Is Natural Gas Headed Towards The $3.5 Mark?

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Includes: CHK, UNG, USO
by: Lior Cohen

During last week, natural gas prices resumed their rally as the future price (August delivery) rose by 7.32% and reached $3.08 - the highest level since the beginning of January. Nonetheless, NG prices are still low in historic perceptive: during the parallel week in 2011 the Henry Hub spot price was nearly $1.66 higher than last week's price. So what is next for natural gas prices? Will this rally continue? Let's examine the recent developments in natural gas markets to try and answer this question.

During the month (up to date) the price of Henry Hub (spot) increased by 10.22%; the future price for August also rose by 9.22%; United States Natural Gas (UNG) price increased by 9.3%. This rise comes after natural gas prices didn't do much during the first couple of weeks of July. Despite the recent rise of NG prices, it doesn't seem to help struggling natural gas producers such as Chesapeake Energy Corporation (CHK).

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Oil Prices

The increase in oil prices in recent weeks and by extension United States Oil (USO) may have also helped NG prices to rise. During July the linear correlation between WTI oil rate and NGF (short term delivery) reached 0.51 (daily percent changes), which is mid-strong and positive. This correlation however varies and should be taken with a grain of salt. If the relation between oil and NG will tighten and oil prices will further rise, it might pull suggest natural gas prices will also increase.

Hot Weather Eases

The weather continues to be hotter than normal but was less hot than in recent weeks. During last week the U.S temperatures (on a national level) were higher by 3.3 degrees than the 30-year normal temperature and 0.6 degrees than the same week in 2011. The hot weather is still keeping the demand for natural gas in the power sector robust and thus may further pressure up natural gas prices.

Demand

During last week the average U.S NG consumption decreased by 1.6%.

The power sector led with a 2.7% decline. The total demand for NG decreased by 1.8% compared with the previous week's levels; on the other hand, it was still 8.8% above the same week in 2011. This means, the demand slightly declined compared to the previous week.

Supply

From the Supply side during last week the gross natural gas production slipped by 0.1%; it was 4% above the production level in 2011. Imports from Canada increased by 2.7% (week-over-week); the imports were also 0.2% higher than the same week in 2011. During last week, the total U.S natural gas supply nearly didn't change on a weekly scale as it declined by only 0.1%. Finally, the natural gas rotary rig count decreased by 20 and settled at 522 rigs. This means the NG supply nearly didn't change during last week.

So the supply didn't change while the demand moderately decline during last week. So it means the natural gas market has loosened up a bit compared to its state a week earlier.

Storage

Natural gas injection to the underground natural gas storage was lower than the injection during the parallel week in 2011 by nearly 28 Bcf. Further the injection was also 41 Bcf lower than the 5-year average injection. The current storage is at 3,163 Bcf for all lower 48 states, which is still nearly 17.5% above the 5-year average. Nonetheless, the gap between the current storage levels and 5-year average storage continues to shrink; at the current rate the gap could nullify around October. Furthermore, I guess at this rate the storage levels will peak early November to reach 3,600.

So what does it mean for natural gas market?

On the one hand, based on the recent changes in the demand and supply, it seems the natural gas market hasn't changed much and perhaps even gotten a bit looser. Oil prices started off the week falling. On the other hand, the NG storage continues to rise but at a much slower pace than in the past. The rig count further falls; the weather continues to be hotter than normal. These data point out to a mixed signal as the progress of the natural gas prices.

I guess natural gas may continue to moderately trade up as long as the warmer than normal weather will keep the demand for natural gas robust and the storage levels will further rise at a slower pace than in the past. Nonetheless, I don't think the current conditions in the NG could sustain another sharp rise in natural gas prices; so the $3.5 mark might be out of reach for the now.

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