The 77 Bcf natural gas storage injection reported today by the U.S. Energy Information Administration (EIA) -- the third bearish disappointment in a row (and the widest of the three) relative to the consensus -- caused very little immediate price response. The report came 4 Bcf above the 73 Bcf consensus (0.6 Bcf/d differential), and far above the low end of the estimates range, which was in the low 60s (2 Bcf/d differential).
The sanguine price reaction likely reflects the market's perception that this year's available storage capacity is more than adequate to accommodate demand under most scenarios. Assuming five "big" injection weeks remaining in this season, 70 Bcf per week, on average, is required to reach the 4.0 Tcf storage exit level, which would be approximately in line with last year once storage capacity additions are taken into account. At this point, it would probably take a 80-90 Bcf per week trajectory to cause any serious "containment" scenario concerns.
With the structural constraint defined by the November storage availability less and less relevant, the market's attention should increasingly turn to the longer-term fundamentals, and the natural gas price uncertainty range will naturally widen. Several factors will require closer scrutiny:
- Well backlog dynamics: A significant part of the backlog, particularly in the Marcellus and Eagle Ford, is driven by the lagging infrastructure. As the off-take capacity is gradually added and the existing capacity is optimized, the supply may increase in big lumps and will not correlate with the rig count. In some instances, the constraints have also impacted the deliverability from the wells that are already online, effectively flattening the decline profiles.
- Timing of the remaining production curtailments coming back to the market: With the short-term contango remaining very steep (the one month December/November Nymex contango is about 28 cents), there is a strong incentive to the operators who still have some production volumes choked back to keep their gas stored in the wells for another month.
- The price level required for the dry gas drilling to accelerate: With the existing well backlog, many operators have their hands full simply maintaining their on-going drilling programs and completing the pre-drilled inventory. The forward curve already provides an incentive to gas companies to keep their active gas-directed rigs working (as there is a hidden "business interruption" cost to releasing and re-hiring a rig and managing other components of the operation). The gas-directed rig count may have already found its bottom. However, at the current price level, the incentive to substantially re-accelerate drilling may not be compelling enough. Several months may pass before the year-end budget processes and additional hedging open doors to incremental capital for dry gas drilling.
- Gas-on-coal competition: While coal-for-gas substitution provides a barrier to quick upward moves in the gas price, switching economics at some point will become a moving target, once the excess thermal inventories show signs of improvement in response to the increased burn.
Storage Statistics Summary
Natural gas storage surplus relative to last year shrank by another 24 Bcf last week, according to the EIA. The pace of injection into storage remains lower than during the same period last year. Using a rolling three-week average to reduce the impact of short-term fluctuations, the weekly year-on-year differential in the injection rate was 34 Bcf/week or 4.9 Bcf/d.
(click images to enlarge)
According to EIA, as of September 28, working gas in storage was 3,653 Bcf. Stocks are 272 Bcf higher than last year at this time, and 281 Bcf above the five-year average of 3,372 Bcf. The surplus relative to the five-year average was 70 Bcf in the East Region, 47 Bcf in the West Region, and 163 Bcf in the Producing Region. The Producing Region has continued to see the fastest inventory growth.
The futures curve continues to provide economic incentive to operators to drill in select, most productive dry gas sweet spots, but renders "Tier II" areas uneconomic.
This discussion of natural gas fundamentals bears relevance to natural gas producer stocks. My natural gas producer index includes: