The weather is heating up and so is the natural gas market; over the past month, the Henry Hub has climbed from around $2 to $2.6-$2.7. But will this rally persist? Let's examine the recent developments in the natural gas market.
Inventories - the gap is shrinking
One of the main changes that transpired in the natural gas market is the closing of the gap between historic levels of natural gas inventories and current levels, as indicated in the following chart.
As you can see, over the past month this year's natural gas storage went from being close to 70% above the levels recorded last year to around 25%; and compared to the 5-year average, the storage dropped from close to 50% higher than normal to 28%. Another way to look at this contraction in the gap between historic storage levels and current levels is the pace of the natural gas buildup: Since the injection season started back in April, the buildup was only 626 Bcf; in comparison, the 5-year average for the same period and time frame was 790 Bcf - roughly 20% lower. Is this a matter of higher demand, lower production or a combination? So far, it seems to be more a demand side story. According to the EIA weekly report, marketed production has remained stable at around 80.6 Bcf per day; this is very close to the levels recorded last year. And even though rigs are still at low levels - Baker Hughes (NYSE:BHI) reported of only 86 operating natural gas rigs, which has remained virtually unchanged over the past couple of months - the EIA still projects a modest gain (of 1%) in annual production compared to 2015. But the demand for natural gas is expected to pick up by 1.7%, year on year, during 2016. Most this rally is attributed to higher consumption in the electric power sector - an expected rise of 5.1% this year. The low natural gas prices (along with the ongoing drop in coal production) have led electric power companies to increase their use of natural gas as an input. And now that this summer has started off hotter than normal; this only raises the demand for natural gas in the power sector. Despite the recent rise in demand, the EIA still expects inventories to reach 4,161 Bcf by the end of the injection season - which is still the highest level on record to start the extraction season.
It's worth noticing that in the future markets there has also been a drop in the Contango; this could suggest that the gap between future prices and current prices is closing so that the market projections less price appreciation in the subsequent months. The decline in the Contango could also suggest a lower adverse impact to the pricing of United States Natural Gas (NYSEARCA:UNG) because of roll decay.
The storage levels are picking up at a slower pace and the demand is rising - the warmer than normal weather also helps drive up the demand for natural gas in the power sector. This shift has led to a recovery in natural gas prices, which are still very low. But considering production isn't falling and storage will remain much higher than normal prices are still expected to maintain their low levels compared to previous years. For more see: Natural Gas is Still Floating… Barely
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