EIA Reports Surprise Gas Build - Analyst Blog

In its weekly release yesterday, the Energy Information Administration (EIA) reported a surprise 2 billion cubic feet (Bcf) addition to natural gas stockpiles for the week ended November 27, far off analyst expectations that hoped for inventories to remain flat, or possibly even show a drawdown.

This takes the current storage level to a new record high of 3.84 trillion cubic feet (Tcf), which is up 14.0% from last year’s level and 14.5% above the five-year range (as clear from the nearby chart from the EIA). Current stocks are 470 Bcf above last year’s level and 487 Bcf above the five-year average. The inventory addition was in sharp contrast to the five-year-average net withdrawal of 43 Bcf and last year’s drawdown of 64 Bcf.

The relentless increase in gas storage levels has meant that even with the storage injection season over, stockpiles continue to grow, a rare event for this time of year. In fact, the latest net injection was the fourth one during the month of November, marking the first time a net injection occurred for each week of November since 2001. At this pace, inventories are well on their way to surpass the maximum capacity of 3.89 Tcf.

Despite the bearish EIA report, natural gas prices (referring to Henry Hub spot prices) have increased dramatically since the last 10 days or so, currently settling at around $4.70 per million Btu (MMBtu). The price rise followed significant decreases that occurred during the previous week (immediately before the Thanksgiving holiday), reflected the usual decrease in demand that generally occurs during a holiday week. 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 2009.

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. Stockpiles have gone on to create new highs this year as the economic downturn eats into demand and natural-gas producers continued to unlock new supplies from onshore natural-gas fields known as shales. To add to this, milder winter forecasts could further depress demand for the fuel to heat homes and businesses.

Weighed down by these factors, the January natural gas contract continued its fall, down to around $4.50 per MMBtu on the New York Mercantile Exchange (NYMEX). Last week, the December 2009 contract expired below $5.00 per MMBtu, just the second such occasion (during the heating season) since 2003. With U.S. natural gas fundamentals remaining weak (storage levels 14.5% above their five-year average), we do not see any sustainable commodity price gains in the near future. 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 (CHK), EOG Resources (EOG), Devon Energy Corp. (DVN), EnCana Corp. (ECA) and Anadarko Petroleum Corp. (APC). We currently rate shares of these companies as Neutral.

Within the small- and mid-cap natural gas E&P space, we prefer to own Cabot Oil & Gas Corp. (COG), reflecting the company’s impressive exposure to the high-return Marcellus and Haynesville Shale plays, as well as its above-average production growth.

EIA Reports Surprise Gas Build – Analyst Blog

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