The federal government’s Energy Information Administration (“EIA”) reported a higher-than-expected increase in natural gas supplies, attributable to moderate weather conditions across the country that led to a decline in electric power consumption.
Stockpiles held in underground storage in the lower 48 states rose by 85 billion cubic feet (Bcf) for the week ended October 1, 2010, above the forecasted range of 67–71 Bcf increase. The latest build compares with last year’s net injection of 68 Bcf and the 5-year (2005–2009) average of 67 Bcf for the reported week.
The current storage level, at 3.50 trillion cubic feet (Tcf), is down 149 Bcf (4.1%) from the last year’s level, but remains 220 Bcf (6.7%) above the five-year average. Natural gas supplies have exceeded the 5-year average for this time of year in each of the past 28 weeks (since March 26, 2010) and are not far from the last year’s record highs at that time.
Though the recent surge in the commodity’s demand (on account of hot weather) 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 comfortably above their five-year average. In fact, the latest build has send natural gas inventories to their highest level since December 11, 2009.
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 45% from the seven-year low reached last July) that signals a supply glut later this year in the face of consumer worries regarding high unemployment and economic recovery.
More importantly, production from dense rock formations (shale) through novel techniques of horizontal drilling and hydraulic fracturing remain robust. In fact, according to Energy Department data, volumes from shale wells rose 71% in 2008 from a year earlier to 2.02 Tcf, accounting for 17% of the country’s natural gas production. This has created a massive oversupply, compelling natural gas prices to slide from $13 per million Btu (MMBtu) four years ago to sub-$4.0 per MMBtu today (referring to Henry Hub spot prices). As there have been more technological breakthroughs, shale gas has become viable in some cases at just $3 per MMBtu.
There are concerns among traders that the market will be oversupplied in the short to medium term, with rig counts going up and onshore production increasing. As per the U.S. Energy Department, domestic gas production will average 61.2 Bcf per day in 2010, up 2.1% from last year. The agency further added that gas inventories are expected to reach 3.69 Tcf in early November, just shy of the record 3.84 Tcf reached last November, when recession slashed energy demand.
The lack of tropical storm activity in the Gulf of Mexico (an energy-rich region representing about 11% of domestic gas output) is also expected to hold back natural gas price increase. Forecasts for mild weather next year has added to the downbeat sentiment.
We believe the weak fundamentals are going to continue to weigh on natural gas prices in the near-to-medium term, translating into limited upside for natural gas-weighted companies and related support plays.
Therefore, we maintain our cautious stance on natural gas-focused exploration and production players such as Anadarko Petroleum Corp. (APC), Chesapeake Energy (CHK), EnCana Corp. (ECA) and Devon Energy Corp. (DVN).
Additionally, we remain skeptical on land drillers such as Nabors Industries (NBR). We believe that the overhang from continued oversupply will lead to an extended period of weakness for North American natural gas prices, resulting in reduced drilling and fracturing activity. In particular, this will affect the fortunes of Nabors – the leading North American land drilling contractor.
All the above-mentioned companies currently retain a Zacks #3 Rank, which translates into a short-term Hold rating.
ANADARKO PETROL (APC): Free Stock Analysis Report
CHESAPEAKE ENGY (CHK): Free Stock Analysis Report
DEVON ENERGY (DVN): Free Stock Analysis Report
ENCANA CORP (ECA): Free Stock Analysis Report
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