Will Natural Gas Fall Below $2.50?

| About: The United (UNG)
This article is now exclusive for PRO subscribers.

Last week, natural gas prices continued their downward trend. The prices of natural gas declined despite the low injection to storage and the continuous hotter-than-normal weather. Will prices continue to fall in the following weeks? Let's examine the recent developments in natural gas markets to try and answer this question.

During the past week, the price of Henry Hub (spot) declined by 4.6%, the future price (short-term delivery) also decreased by 1.8%, and United States Natural Gas (NYSEARCA:UNG) price decreased by 1.6%. The recent fall of natural gas prices may have also contributed to the recent decline of natural gas and oil producer stocks such as Exxon Mobil (NYSE:XOM).

The chart blow shows the rise and fall of the Henry Hub spot and future (short-term delivery) prices during recent weeks.

Click to enlarge images.


From the supply side, the gross natural gas production rose by 0.2% during last week; it was 2.4% above the production level in 2011. Imports from Canada, on the other hand, decreased by 4.4% (week over week), and the imports were also 5.6% below the imports recorded during the same week in 2011. The total U.S. natural gas supply declined on a weekly scale by 0.4%. Finally, the natural gas rotary rig count decreased by three and settled at 495 rigs. Therefore, the NG supply contracted again during last week.


Natural gas injection to the underground natural gas storage was only 20 Bcf, which was much lower to the injection during the parallel week in 2011 -- it was back then 50 Bcf. Furthermore, the injection was also 20 Bcf lower than the five-year average injection. The current storage is at 3,261 Bcf for all lower 48 states, which is still nearly 12.5% above the five-year average. The difference between the current storage levels and five-year average storage continues to contract; at the current rate the difference could nullify, based on my rough estimate, around October 2012. The table below shows my crude estimate based on the gaps between recent injections and five-year injections.


According to the EIA, during last week the average U.S. NG consumption declined 2.7%. The power sector led the fall with a 6.8% drop (week over week). Alternatively, many other sectors' demand, such as residential/commercial sectors, increased during last week. The total demand for NG decreased by 2.4% compared with the previous week's levels; it was 4.2% above the demand during the parallel week in 2011.

Both the natural gas supply and demand moderately declined during last week, and it seems that the supply declined by a lower pace than the demand. Thus, the natural gas market has loosened a bit compared to its condition a week earlier.

Warmer Than Normal Weather Subsides

The weather remains warmer than normal, but was less hot than in July. According the EIA, July was the third hottest month on record. This extreme heat increased the demand for natural gas consumption in the power sector -- there was a rise in air conditioning usage. But since then the heat has subsided and is expected to continue in the weeks to follow. During the past week, the U.S. temperatures (on a national level) were higher by 3.1 degrees than the 30-year normal temperature and only 0.4 degrees warmer than the same week in 2011.


Natural gas prices tend to decrease during August: The Henry Hub spot price declined by 8.9% during August 2011, by nearly 16.6% during August 2010, by 39.1% during August 2009, and by 17.7% during August 2009. Up until now, this strong seasonality effect seemed to take place this year as well. This downward trend could continue in the following weeks.

So what does it mean for the natural gas market?

Based on the recent developments in the natural gas demand and supply, it seems the natural gas market has loosened. The demand for natural declined by a higher rate than the supply did; the weather cooled down a bit and contributed to the decline in demand. The seasonality effect along with the expectations of another drop in temperatures could suggest the pressures from the demand side will subside further. This may result in another decrease in natural gas prices in the next couple of weeks. On the other hand, the decline in supply is likely to keep natural gas from tumbling down. The natural gas rig count continues to fall, as the injections are still well below last year and the five-year average injections.

The bottom line is that natural gas will likely continue to dwindle -- but not by much -- as the weather cools down and the demand for natural gas falls.

For further reading: "What's Up With Natural Gas? Nothing Much."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.