Another Natural Gas Buildup

The storage overhang in the U.S. natural gas market shows no sign of easing. With domestic production continuing to outpace recession-hit demand, despite the sharp retrenchment in the rig count, the commodity appears to be on track to exit the summer injection season with an all-time high storage build. Today’s bearish report is expected to stall, if not altogether reverse, the emerging strength in natural gas prices over the last few days that pushed it above the $4 mark.

To play this natural gas outlook, we continue to rely primarily on select E&P players such as EnCana (ECA), XTO Energy (XTO) and Chesapeake (CHK), who have the bulk of this year’s production hedged at attractive prices and have access to resource-rich assets can be profitably operated in the current low-price environment.

We remain wary of land drillers such Nabors (NBR) and 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. As such, we remain unconvinced of the sustainability of recent gains made by the land drillers and other onshore U.S. centric service players.

The Energy Information Administration (EIA) reported today a bigger-than-expected 114 billion cubic feet (Bcf) weekly addition to natural gas stockpiles for the week ended June 12th. This takes the current storage level to 2.44 Trillion cubic feet, which is up 32.1% from last year’s level and 22.6% above the five-year range (as clear from the nearby chart from the EIA). Current stocks are 622 Bcf above this last year and 472 Bcf above the five-year average.

Due to the pronounced seasonal nature of natural gas consumption, stockpiles are built in the summer months and consumed in the winter heating months. As such, we have natural injections in the summer, as at present, and withdrawals in the winter. The storage level at the end of summer injection period has a direct bearing on natural gas prices in the winter heating months.

Current expectations are for a reversal in domestic production in the coming months as the lagging effect of the sharp drop in domestic drilling activity. Partly offsetting the production drop is the expected ramp up of LNG imports this year. If weekly injections do not drop materially from the trend established over the last many weeks, then we may actually get to a new record of close to 4 Tcf in storage at the end of the current injection period.

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