The reason natural gas has traded below $3 for much of the spring and summer has been to encourage utility companies to switch their power generation from coal to natural gas in hopes of preventing natural gas storage from reaching storage capacity in the Fall of 2012. The warmest winter in the last 100 years caused natural gas to exit the withdrawl season with a huge storage glut compared to last year and the five year average. The low prices have done their trick and according to the EIA Weekly Natural Gas Report for the week ended August 31, 2012, natural gas storage has dropped to 329 Bcf above the five year average. The question for the market is how much further does natural gas storage need to fall compared to the five year average to avoid having to shut-in production because there is no room to store it? An earlier article - Natural Gas Storage Will Not Reach Storage Design Capacity in 2012 - predicted natural gas production would not need to be shut-in because it would run out of storage room. It discussed factors such as storage design capacity, the drop in the rig count, and the impact of coal to gas switching.
The market has been too focused on the total lower U.S. 48 state storage average rather than the maximum storage reached in the last five years. And the market has not focused on the three separate producing and storage regions of the lower 48 states. The EIA releases a link to data for the minimum and maximum storage levels reached over the last five years for each of the three regions in its weekly report. An examination of the total maximum storage level of 3,353 Bcf reached in one of the last 5 years shows that the current storage level of 3,402 Bcf is only 49 Bcf above the combined maximum storage level. But each region has its own storage capacity and examining the maximum storage reached in each region, albeit in different years, gives a clearer picture of how close natural gas production is to having to be shut-in due to storage constraints. Specifically, the current storage in the East Region was reported to be 1,793 Bcf, which is 7 Bcf below the 1,800 Bcf proven maximum storage for August 31 for the East Region. It is highly unlikely the East Region will run out of storage capacity this Fall. Current storage in the West Region is 492 Bcf, which is 16 Bcf above the maximum proven storage of 476 Bcf. Due to lower hydroelectric power generation this year, and the outage of the San Onfre Nuclear Power Plant in Southern California, the West Region is also unlikely to have to shut-in production because of a lack of storage capacity. That leaves the Producing Region as the one to watch.
The Producing Region consists of New Mexico, Kansas, Oklahoma, Texas, Louisiana, Arkansas, Mississippi, and Alabama. The latest EIA weekly report shows storage has reached 1,117 Bcf as of August 31, 2012. That is 174 Bcf above the five year average for the Producing Region of 943 Bcf. But the maximum proven storage is 1,092 Bcf which means the Producing Region is only 26 Bcf above maximum proven storage. The Producing Region had a draw of 7 Bcf in the latest report because of shut-in production from Hurricane Isaac. The EIA has reported a similar amount of production in the Producing Region has been shut-in this week from Hurricane Isaac. Additionally, it was hotter in the Producing Region this week than last week. That means the Producing Region will likely show another draw in storage in next week's report. The maximum storage reached for the Producing Region for the week ending September 7 is 1,104 Bcf. This will put the Producing Region close to being within the maximum proven storage range. The drop in the rig count has finally led to a decline net natural gas supply versus the previous year. Net natural gas supply dropped by an average of over 3 Bcf per day in August versus August of 2011. That trend should accelerate in September and October. Even if coal-to-gas switching were to end right now, it is unlikely the Producing Region would run out of storage capacity causing natural gas production to have to be shut-in. Many market participants still believe natural gas maximum storage levels will be reached this Fall because we are running 329 Bcf above the five year average. In reality we are under proven maximum storage in the East Region, we are only 16 Bcf above proven maximum storage in the West Region, and we are only 26 Bcf above maximum proven storage capacity in the Producing Region.
This means natural gas prices will be rising sooner than anticipated to end coal-to-gas switching. Natural gas will need to rise above $4 to end all coal-to-gas switching in the Appalachian part of the country. Investors can take advantage of the coming rise in natural gas prices by buying the United States Natural Gas Fund (UNG), which is an ETF designed to mirror movement in the current futures price of natural gas. Additionally, many primary natural gas producers are trading much lower than their highs. An upward tick in natural gas prices would have a big impact on the bottom lines of companies like Chesapeake Energy (CHK), Devon Energy (DVN), Encana (ECA), Magnum Hunter Petroleum (MHR), Newfield Exploration (NFX), Crimson Exploration (CXPO), and Goodrich Petroleum (GDP).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.