Natural Gas Gains: Not Convinced of Sustainability

by: Zacks Investment Research

Last week, the federal government’s Energy Information Administration [EIA] reported a lower-than-expected rise in natural gas supplies. Stockpiles held in underground storage in the lower 48 states rose by 2 billion cubic feet [Bcf] for the week ended November 20.

This takes the current storage level to a new all-time high of 3.84 trillion cubic feet [Tcf], which is up 11.8% from last year's level and 13.0% above the five-year range (as clear on the chart from the EIA). Current stocks are 404 Bcf above last year’s level and 442 Bcf above the five-year average.

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The relentless increase in gas storage levels has meant that stockpiles are already 99% full. At this pace, inventories are well on their way to surpass the maximum capacity of 3.89 Tcf.

However, the bullish EIA report -- the smallest weekly inventory build since March -- coupled with indications of an economic rebound and the approaching colder weather, have seen natural gas prices (referring to Henry Hub spot prices) rally to around $4.00 per million Btu [MMBtu].

But prices are still way off the July 2008 highs, when they reached over $13 per MMBtu, before trending down to a 7-year-low level of sub-$2 per MMBtu in September.

Continued strong domestic production (from a number of unconventional natural gas fields) and recessionary consumption (due to the economic downturn), particularly in the industrial sector, are at the core of the commodity's current woes. Additionally, the Atlantic hurricane season did little to disrupt offshore production and onshore refineries.

With U.S. natural gas fundamentals remaining weak (storage levels are 13% above their five-year average), we are not fully convinced about the sustainability of the commodity’s current gains. This translates into limited upside for natural gas-weighted companies and related support plays.

As a result, we remain cautious on natural gas-focused E&P players such as XTO Energy (XTO), Chesapeake Energy (NYSE:CHK), EOG Resources (NYSE:EOG), Devon Energy Corp. (NYSE:DVN), EnCana Corp. (NYSE:ECA) and Anadarko Petroleum Corp. (APC). We currently rate shares of these companies as Neutral.

We also maintain our Neutral recommendations for land drillers such as Nabors Industries (NBR) and Patterson-UTI Energy (PTEN), as well as natural gas-centric service providers such as BJ Services (BJS), given the extent of excess capacity in the sector that is expected to weigh on dayrates and margins well into next year.

Oil majors like BP Plc (NYSE:BP) that have significant natural gas operations are also expected to remain under pressure until pricing and demand improve further.

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