Natural Gas Storage Fears And Realities

Includes: CHK, EXC, KWK, PEG, SWN, UNG
by: Paulo Santos

In the natural gas (NYSEARCA:UNG) market, there's an underlying fear that this year, storage capacity might he exhausted way ahead of time, before the usual end to the injection cycle (November). This happens because the 2011/2012 Winter was one of the warmest on record, it led to a deep plunge in natural gas demand for heating, which together with increased production from the shale boom brought us a large glut and record natural gas in storage at the beginning of the injection cycle.

The chart and table below (source: EIA weekly storage report) illustrate the present situation. Natural gas inventory remain well above the historical range, indeed, as the table shows, it stands 32.9% above where it stood last year, and 31.4% above the 5-year average. Doing the math, observers and analysts conclude that there's an excess of 713 Bcf over last year, and 687 Bcf versus the 5-year average. These numbers seem insurmountable in the barely 6 months that stand between us and the regular injection cycle end. Indeed, there are 168 days between today and the typical top (23 November week). That's 24 weeks, to eat up the 713/687 Bcf excess. With storage at 2877 Bcf, and estimated peak storage at 4000 Bcf, the average injection in these 24 weeks would have to remain at 46.8 Bcf/week for storage to be enough. So numbers like this week's 62 Bcf injection, although only 6 Bcf over estimates, seem scary.

Click to enlarge

Click to enlarge

But is this all there is to it?

I say it isn't. Indeed, I'll show how things are being blown out of proportion by a small detail. This detail is that to get into the normal range for natural gas inventory, one does not have to reach last years' number, or the 5-year average. Indeed, natural gas merely needs to reach the top of the range! The last time natural gas had inventories that established that top of the range, it traded between $3.25 and $6.00. The top of the range is neither 713 nor 687 Bcf below the present inventory level. It's "just" 463 Bcf below today's level. And indeed, today's inventories are not 31.4% or 32.9% above the top of the range. They're just 19.2% above it.

And what's more, the inventory level has been getting closer and closer to the top of the range, indeed, in the last 9 weeks inventories got closer by an average of 38 Bcf per week. In the last 4 weeks, things were a bit worse and it still got closer by 24 Bcf per week. And in this last week - the one with the plunging apocalypse - it got closer by 33 Bcf. If we use the 9 week average, natural gas would hit the top of the range within 12 weeks. If we use the 4 week average, it would hit the top of the range within 19 weeks. As it stands, both are well within the available time (24 weeks). Indeed, at the more optimistic rate, it would get there particularly quickly.

Not only are the inventories much closer than they seem by merely looking at the weekly storage update, but there are other developments that merit consideration. One is that production is already stagnated or falling. This is visible in the EIA weekly updates, with the negative bias on week to week supply numbers, and the trend towards lower and lower year-over-year growth. Also in those same updates we can clearly see that demand has kept strong. Production is certainly not about to jump back, because rigs looking for natural gas have been dropping strongly since October 2011, and shale wells see very rapid production drops. So if anything, this production drop is set to steepen.


Even the most bearish fact about natural gas storage is not as bearish as it seems. The fears that storage will be exhausted are presently clearly overblown, unless, of course, we get a mild summer.

Indeed, with the present fundamentals the most likely course for natural gas is to go up even during 2012. Also likely, we'll start seeing production drops during 2012, which will steepen considerably during 2013. At this point, the situation is such that we might even witness a natural gas shortage during 2013.

If there was a valid reason to be bearish on natural gas in the past, that reason is long gone. However, while I believe natural gas will head up, I am not necessarily positive on shale-focused natural gas producers like Chesapeake (NYSE:CHK), Southwestern Energy (NYSE:SWN) (a small aside, I think SWN is better than CHK) or Quicksilver Resources (NYSE:KWK). The reason why I don't like these companies is tied with the reason I believe natural gas will head up: because shale wells quickly see very large production drops, and it will be these companies suffering those production drops. I still expect some of the major beneficiaries of a higher natural gas price to be companies that generate power from other sources, companies such as Exelon (NYSE:EXC) or Public Service Enterprise Group (NYSE:PEG).

Disclosure: I am long EXC.