Natural Gas Stocks Dip Again - Analyst Blog

In its weekly release, the Energy Information Administration (EIA) reported a 124 billion cubic feet (Bcf) decline in natural gas supplies for the week ended December 25, 2009. The inventory decline, though smaller-than-expected, was the fourth in as many weeks. This has finally started to erode the record-high storage amounts, as frigid temperatures continue to chill major population centers in the U.S.

Though the heating season officially began on November 1, 2009, net injections have continued through November on a national basis. As a result, gas in storage still remains well above the normal range at this time of the year.

The current storage level, at 3.28 trillion cubic feet (Tcf), is up 13.1% from last year’s level and 13.6% above the five-year range (as clear from the chart below from the EIA). Current stocks are 379 Bcf above last year’s level and 391 Bcf above the five-year average.

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 continue to unlock new supplies from onshore natural-gas fields known as shales. Months of mild weather further weakened demand for the fuel to heat homes and businesses.

Given the depressed state of the commodity, the lower-than-anticipated drop in reserves sent natural gas prices lower during the last few days of 2009. However, the commodity has fared extremely well during the month of December, giving returns of over 35% on the back of sustained inventory drawdown. Natural gas prices ended the year at about $5.50 per million Btu (MMBtu), up more than 100% from their September 2009 lows. This was also helped by the news that oil major ExxonMobil (XOM) has decided to pick up unconventional natural gas producer XTO Energy (XTO) in a $41 billion all-stock deal.

Nevertheless, we are not fully convinced about the sustainability of natural gas’ current gains, as the specter of a continued glut in domestic gas supplies (storage levels remain 13.6% above their five-year average) still weighs and the inventories remain higher compared to averages for this time of year. This translates 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 producers bet on forecasts for colder weather and the lagging effect of the sharp drop in domestic drilling activity takes hold.

Until then, we remain cautious on natural gas-focused E&P players such as 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.

We also maintain our Neutral recommendations for land drillers such as Nabors Industries (NBR), Patterson-UTI Energy (PTEN) and Helmerich & Payne, Inc. (HP), as well as natural gas-centric service providers such as Halliburton Company (HAL), given the extent of excess capacity in the sector that is expected to weigh on dayrates and margins well into next year.

Oil majors like BP Plc (BP) that have significant natural gas operations are also expected to remain under pressure until pricing and demand improve further.

Natural Gas Stocks Dip Again – Analyst Blog

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