Natural Gas Up on Huge EIA Draw - Analyst Blog

The federal government’s Energy Information Administration (EIA) reported a bigger-than-expected decline in natural gas supplies. Stockpiles held in underground storage in the lower 48 states fell by 64 billion cubic feet (Bcf) for the week ended December 4. The large inventory decline came as frigid temperatures throughout the country finally started to erode record-high storage amounts.

This takes the current storage level to 3.77 trillion cubic feet (Tcf), which is still up 14.3% from last year’s level and 15.7% above the five-year range (as clear from the nearby chart from the EIA). Current stocks are 472 Bcf above last year’s level and 513 Bcf above the five-year average.

Despite exceeding market expectations, the inventory withdrawal (that came about two or three weeks behind schedule) was lower than the five-year-average drawdown of 90 Bcf and last year’s withdrawal of 66 Bcf. In fact, though the heating season officially began on November 1, net injections have continued through November on a national basis. This means that gas in storage remains well above the normal range at this time of the year.

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. Months of mild weather further weakened demand for the fuel to heat homes and businesses.

Given the depressed state of the commodity, the large drop in reserves (the first time since March 2009) sent natural gas futures prices on the New York Mercantile Exchange (NYMEX) to an 11-month high.

Though we welcome the bullish EIA data, 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 15.7% 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.

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.

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 BJ Services (BJS), given the extent of excess capacity in the sector that is expected to weigh on dayrates and margins well into next year.

Natural Gas Up on Huge EIA Draw – Analyst Blog

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