What’s Weighing On Natural Gas?

In its weekly natural gas status report, the Energy Information Administration (EIA) reported last Thursday that gas in storage totaled 3,167 billion cubic feet (Bcf) for the week ended December 12, 2008. This represents a net withdrawal of 124 Bcf from the preceding week, the largest this heating season, but modestly below the 128 Bcf withdrawn this week last year and on average over the last five years.

Current storage levels are now 1.3% below last year’s level, but still above the 5-year average by 3.7%. Colder than average weather prevailed in all regions east of the Rockies, helping increase heating-related consumption and playing a role in the sizable withdrawal. In general, the overall temperature for the week was 35.9 degrees Fahrenheit, about 2.7 degrees below normal.

Natural gas prices rallied earlier this year, reaching over $13 per million Btu (MMBtu) in July, before trending down. Prices have since dropped more than 50% to the current level of around $5.80 per MMBtu (we are referring to Henry Hub spot prices here).

Keeping prices low is a combination of soft demand due to the economic downturn and strong supplies due to increased production from a number of unconventional natural gas fields such Northeast Texas’ Barnett Shale.

While colder-than-normal temperatures during the heating season should help natural gas prices to some extent, the overall outlook continues to remain weak. The commodity’s weak near-term outlook, coupled with the ongoing credit market turmoil, has prompted exploration and production players (natural gas producers) to curtail capital expenditure plans for 2009.

While these curtailments have weighed on the business prospects of onshore drillers such as Nabors (NBR) and Patterson-UTI (PTEN) and other players, they are expected to bring down natural gas supplies in the second half of 2009.

This is expected to result in a much favorable environment for E&P players this time next year and in 2010. Our preferred E&P names, such as EnCana (ECA), EOG Resources (EOG), XTO Energy (XTO) and Chesapeake (CHK) own quality assets that enable them to cost effectively operate even in a low-price environment.

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