Deconstructing The Recent Natural Gas Rally - Will It Last?

Includes: CHK, UNG
by: Lior Cohen

The recent rally in natural gas prices and by extension United States Natural Gas (NYSEARCA:UNG) has erased the sharp fall in prices recorded up to mid-April. What had occurred in the natural gas market that warrants such a sharp turn in the price of UNG? Only a short time ago we expected natural gas prices might even hit the $1 mark. So what has changed? Let's examine the fundamentals to see if there is an explanation for this shift and thus also speculate whether this rally will last?

Since April 19th the Henry Hub rose by 38.4%% and the United States Natural Gas price by 36.4%.

The chart below presents the natural gas prices (spot price) and United States Natural Gas during 2012.

Click to enlarge

There are some who ascribe the recent rise in natural gas prices or United States Natural Gas to the expectations of a warmer than normal weather in the U.S this summer. As of last week on a national level, the US temperatures were 4.4 degrees warmer than the 30-year norm and 2.6 warmer than the same period last year. So the current weather is a bit warmer and if it will continue, the demand for electricity might rise, which will drive up the natural gas consumption.


Let's not forget that it's not uncommon for natural gas prices to rise during May through June. Last year natural gas prices rose by nearly 15% between mid-May and mid-June; in 2010 natural gas prices rose by nearly 29% between a similar time frame;

So this rally could be just a seasonality effect that will end by mid to late June before natural gas prices resume their descent.


During the last week, the average U.S NG consumption declined by 5.05%.

The power sector led the fall with a 10.92% decline. While the total demand for NG was 4.74% below the previous week's levels, it was 6.22% above the same week in 2011.


From the Supply side, some attribute this rise in price to an expected decline in the U.S natural gas production. The ongoing fall in the stock price of Chesapeake Energy Corporation (NYSE:CHK), the second largest natural gas producer in the U.S, to its lowest level since March 2009 (especially after the downgrade of the company by a leading rating agency) may have also fueled the speculation around the natural gas market that might tighten in the weeks to come.

But in fact, during last week the gross natural gas production increased by 0.17% and was also 3.67% above the production level in 2011. The total supply of natural gas rose by 0.34% during last week. Having said that the natural gas rotary rig count fell by 8 and reached 598.

So the total demand and supply are higher than last year, but the demand growth is higher than the growth in supply.


This higher growth in demand over supply might explain the lower than last year injections to the underground natural gas storage; the current storage is at 2,667 Bcf for all lower 48 states, which is still nearly 40% above last year and 5-year average.

Click to enlarge

During the past three weeks the injections were lower than the injections during the parallel week in 2011 by nearly 30 Bcf each week. If this trend continues the storage level will reach 3,800-4,000 Bcf by November, which isn't higher than the normal storage levels.

But this drop in injections is likely to be due to lower imports and productions than demand (as mentioned above). This situation could change promptly with the rise in natural gas prices. If the natural gas market further tightens, the supply is likely to pick up again and the natural gas prices will resume their descent.

Therefore, I still speculate this rally in natural gas prices won't last long. The storage levels are still high and there could be just a seasonality effect that pushes the prices up for a short period. Finally, if the demand further pushes up natural gas prices the imports and production will likely pick up again, which will bring prices back down.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.