Natural Gas Stockpiles Rise Less - Analyst Blog

The federal government’s Energy Information Administration (EIA) reported a lower-than-expected increase in natural gas supplies, reflecting warmer-than-normal temperatures and storm-related production shut-ins resulting from Hurricane Alex.

Stockpiles held in underground storage in the lower 48 states rose by 60 billion cubic feet (Bcf) for the week ended June 25, 2010. The latest build was about 27% lower than the 5-year (2005-2009) average and 18% below the year-ago injection.

The current storage level, at 2.68 trillion cubic feet (Tcf), is down 27 Bcf (1%) from last year’s level but remains 287 Bcf (12.0%) above the five-year average. Natural gas supplies have exceeded the 5-year average for this time of year in each of the past 14 weeks and are not far from last year’s record highs at that time.

Though the ongoing surge in the commodity’s demand has erased a hefty surplus over last year’s inventory level, following a high of 101 Bcf for the week ending April 23, the specter of a continued glut in domestic gas supplies still exists, with storage levels remaining 12% above their five-year average. In fact, the latest build, though below market expectations, has send natural gas inventories to a level not normally reached until after the third week of July.

Further pressurizing the commodity is the rapid rise in the number of drilling rigs working in the U.S. (the natural gas rig count has climbed 44% from a seven-year low reached last July) that signals a supply glut later this year in the face of sluggish industrial activity.

More importantly, production from dense rock formations (shale) remains robust. In fact, the share of shale gas in the country’s natural gas production has shot up from zero to 8% in the last decade. This has created a massive oversupply, sending natural gas prices plummeting from $13 per million Btu (MMBtu) four years ago to just around $5.0 per MMBtu today (referring to Henry Hub spot prices). As there are more technological breakthroughs, shale gas has become viable in some cases at just $3 per MMBtu.

Recent forays by Reliance Industries Ltd. and BG Group into southern U.S. shale assets further points to the growth potential in this space. India ‘s largest publicly traded company, Reliance Industries, signed a $1.3 billion agreement to acquire 118,000 acres in the Eagle Ford shale field owned by Pioneer Natural Resources (PXD). On the other hand, U.K’s BG Group, through a joint venture with EXCO Resources (XCO), paid Houston-based Southwestern Energy Co. (SWN) $355.8 million for properties in the Haynesville and Bossier shales.

There are concerns among traders that the market will be oversupplied in the short- to medium-term, with rig counts going up and industrial demand still struggling due to the weak economy. These factors translate into limited upside for natural gas-weighted companies and related support plays.

The gap between supply and demand is expected to reverse in the coming months as natural gas producers bet on the improving U.S. economy, the forecast of an active hurricane season, and predictions of a heat wave on the horizon.

Until then, we maintain our cautious stance on natural gas-focused E&P players such as EOG Resources (EOG), Anadarko Petroleum Corp. (APC), Chesapeake Energy (CHK), EnCana Corp. (ECA) and Devon Energy Corp. (DVN).

In particular, we remain concerned about EnCana (Zacks #4 Rank, or Sell) due to its extensive natural gas exposure. Because of low prices and faltering natural gas demand in the face of abundant supply, EnCana, North America’s largest natural gas producer, recently decided to shut in some wells in each of Canada and the U.S. Earlier this year, U.S. gas producer Chesapeake cut 400 million cubic feet a day of production.

The remaining companies (EOG, Anadarko, Chesapeake and Devon) currently have Zacks #3 Ranks (Hold) rating, meaning that these stocks are expected to perform relatively at par with the overall market during the next 1-3 months. Therefore, investors should maintain their current positions in the stocks over this timeframe.

Additionally, we remain skeptical on land drillers such as Nabors Industries (NBR) and Helmerich & Payne (HP), as well as natural gas-centric service providers such as Halliburton Company (HAL) — all with Zacks #3 Ranks. Although we expect the land rig count to continue with its steady rise during 2010, the large amount of excess capacity in the sector will weigh on day rates and margins well into the year.

Natural Gas Stockpiles Rise Less – Analyst Blog

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