Is The Natural Gas Rally Over?

Sep.17.12 | About: The United (UNG)

Last week, natural gas prices changed direction and hiked until the last day of the week. According to the recent EIA report, natural gas injection was slightly higher than expected but still low for the season. The rise in temperatures in the U.S. may have been among the reasons for the recent recovery of natural gas prices. Will natural gas prices resume their rally? Let's examine the recent changes in natural gas market and examine what is next for natural gas.

During last week, the price of Henry Hub (spot) rose by 7.7%; furthermore, the future price (short-term delivery) hiked by 9.7% and the United States Natural Gas (NYSEARCA:UNG) price also increased by 10.2%. The recent rise in the price of natural gas may have also helped rally some natural gas and oil producers' stocks, such as Chesapeake Energy Corporation (NYSE:CHK). During last week, the shares of the company rose by 0.9%.

As seen below, the prices of the Henry Hub future (short-term delivery) and spot rose during most of last week.

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The chart below shows the developments between the spread of future (short-term delivery) and spot prices during the year. In recent weeks, natural gas has shifted from backwardation to contango, which could suggest the market is anticipating a rise in natural gas prices.

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Storage

Natural gas injection to the underground natural gas storage was only 27 Bcf, which was lower than the injection during the parallel week in 2011 (back then it was at 87 Bcf). Furthermore, the injection was also 49 Bcf lower than the five-year average injection. The current storage is at 3,429 Bcf for all lower 48 states, which is nearly 9% above the five-year average. This means the difference between the current storage levels and five-year average storage continues to contract. If future injections start to exceed the injections from recent years, the difference could expand. The weather is likely to keep affecting future injections.

Supply

From the supply side, gross natural gas production increased by 3.1% during last week; it was also 2.2% above the production level in 2011. Imports from Canada, on the other hand, declined by 6.4% (week over week); the imports were 7.7% above the imports recorded during the parallel week in 2011. The total U.S. natural gas supply rose on a weekly scale by 2.3%. Finally, the natural gas rotary rig count declined by 21 and settled at 452 rigs. Thus, the NG supply expanded during last week.

Demand

According to the EIA, the average U.S. NG consumption declined 5% last week. The power sector led the fall with a 14.6% drop (week over week). Alternatively, the residential/commercial sector's NG demand hiked by 17.6% (week over week). The total demand for NG fell by 4.9% compared with the previous week's levels; it was still 13.4% above the demand levels during the same week in 2011.

So the natural gas supply expanded while demand contracted last week. Thus, the natural gas market has loosened compared to the previous week.

Weather Gets Hotter

The weather was warmer than normal last week, as U.S. temperatures (on a national level) were higher by 5.1 degrees than the 30-year normal temperature and also 4 degrees higher than the same week in 2011. This rise in temperatures reflects only in a rise in demand for natural gas in the residential/commercial sector, as indicated above, and not in the power sector. Since the residential/commercial sector accounts for less than 10% of total demand, this rise didn't have a strong impact on the national demand for natural gas.

Nonetheless, if temperatures remain high, the demand not only in the residential/commercial sector but also in the power sector is likely to increase. Hurricane season is likely to cause uncertainly around the effect it could have on natural gas production. Finally, if there aren't any additional tropical storms or hurricanes to adversely affect production or damage NG infrastructure, then natural gas production is likely to rally.

So what's the bottom line?

Based on the recent changes in the natural gas demand and supply, it seems the natural gas market has loosened up. But the rise in temperatures, the low injections, and the decline in natural gas rigs are likely to keep natural gas prices high or even rising in the near future. Furthermore, since we are still in hurricane season, there is uncertainty with regard to the adverse effect the weather could have on production for a short period.

If demand rises again, if the weather remains warmer than normal, and if the natural gas injection will continue to be lower than in past years, then natural gas prices will likely resume their rally. Nonetheless, I still think natural gas will remain below or around the $3 mark.

For further reading, see "Will Natural Gas Resume Its Rally?"

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.