The big issue concerning the natural gas market is whether natural gas storage will exceed storage capacity before the end of the injection season. Last April, I wrote an article titled Natural Gas Spike Will Be Bigger And Come Sooner Than Expected. The point of the article was that coal to gas switching and a decline in the rig count could allow natural gas storage to avoid reaching storage capacity before the end of the injection season. At the end of April, natural gas storage was running 960 Bcf above the five year average. Now, according to the EIA Weekly Natural Gas Report, natural gas storage is running 357 Bcf above the five year average. That is a decline of over 600 Bcf in four months. The Design for Storage Capacity is 4.3 Tcf to 4.4 Tcf, but only 4 Tcf to 4.1 Tcf is proven. Natural gas storage will need to end the storage season below 4 Tcf for prices of natural gas to have a significant rally. For that to happen, natural gas storage will need to drop another 150 Bcf to 200 Bcf versus the five year average by the end of October.
At the end of July, I wrote that the Natural Gas Storage Glut Could Become A Deficit By October based on the downward trend in the storage glut. At that time, the natural gas storage surplus was still 435 Bcf above the five year average. The reason the downward trend in storage slowed in late July and August was due to the heat. For example, Texas does not have a significant excess of power generating capacity in the summer. The natural gas peak plants were all running last year as well as this year. So Texas and other hot areas of the country did not have coal to gas switching for the hottest parts of the summer. But coal to gas switching will return in September and October at current prices.
The biggest risk to the call was the weather. The weather has turned bullish for natural gas. It will be warmer than normal for large parts of the country the next two weeks. More significantly, Hurricane Isaac has stormed into the Gulf and has landed in Louisiana. Because Isaac has been classified as a "minimal" hurricane, natural gas futures have sold off to the lowest level of the last few weeks. However, Hurricane Isaac is a very large storm and the pressure has been measured as low as 974 mbar. On the Saffer-Simpson Hurricane Scale, a Category Two Hurricane has pressure between 965 mbar to 980 mbar. Isaac is more powerful than forecast and he's hitting the heart of off-shore and close-onshore natural gas production. This will accelerate the downward trend in natural gas storage versus the five year average. Once it is obvious the natural gas storage glut will not exceed proven storage capacity, prices will be poised to rise. Now looks like the time to pull the trigger.
The natural gas rig count is now below 500 rigs and production is now running 2 Bcf per day below last year and is still falling. So what price will natural gas prices have to rise to raise the rig count back towards the 800 rigs needed to stabilize supply? Some think $4 mcf gas will be sufficient as plays such as the Marcellus and some liquids rich plays are profitable at those prices. Others think the all-in costs for dry natural gas plays, such as the Haynesville, Fayetteville, and Barnett shale, are closer to $6 mcf. These plays will need to be drilled in-order to create enough of a long-term supply of natural gas.
Still others think exploration and production companies are shifting their capital expenditure budgets to liquids where rigs provide $10 mcf to $17 mcf in value vs dry gas rigs. The debate is over the price needed to raise the rig count. Right now the market is priced for natural gas prices to return to the $4 range in the winter. If the market requires $6, there is a potential 50% rise in natural gas strip prices. But if the market requires $10 plus, there is a chance to have a triple or more in natural gas prices, heading into the winter of 2013.
There are several ways to play the coming flip in natural gas prices. For the average small investor, natural gas ETFs like the United States Natural Gas Fund (NYSEARCA:UNG) and the United States 12 Month Natural Gas Fund (NYSEARCA:UNL) could be the simplest way to play the flip. Others may want to a look at E&P companies with heavy exposure to natural gas, like Chesapeake Energy (NYSE:CHK), Encana (NYSE:ECA), Devon Energy (NYSE:DVN), Petroquest (NYSE:PQ), or Magnum Hunter Resources (MHR).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.