The federal government’s Energy Information Administration (EIA) reported an in-line decline in natural gas supplies. Stockpiles held in underground storage in the lower 48 states fell by 172 billion cubic feet (Bcf) for the week ended Feb. 19, 2010.
The inventory decline was the 12th in as many weeks. This has finally started to erode the record-high storage amounts, as steady cold weather continued to kick up demand in major gas-consuming regions in the U.S.
Though the heating season officially began on Nov. 1, 2009, net injections continued through November on a national basis. As a result, until recently, gas in storage remained well above the normal range at this time of the year.
However, the ongoing surge in the commodity’s demand has erased a hefty surplus over last year’s inventory level and significantly trimmed the excess over the five-year average level.
The current storage level, at 1.85 trillion cubic feet (Tcf), is down 2.9% from last year’s level but remains slightly above (0.7%) the five-year range (as clear from the following chart from the EIA). Current stocks are 56 Bcf below last year’s level (the first time they have been below year-before levels in 13 months) and 13 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 went on to create new highs last year as the economic downturn ate 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. As a result, natural gas prices (referring to Henry Hub spot prices) trended down to a 7-year-low level of sub-$2 per million Btu (MMBtu) in Sept. 2009.
However, on the back of the sustained inventory drawdown, the commodity staged a phenomenal recovery, breaching the $5.70 per MMBtu level during early Feb. 2010. Things appear to be getting better for the natural gas players, with cold weather slowly cleaning up the storage surplus.
Having said that, the specter of a continued glut in domestic gas supplies (storage levels remain 0.7% above their five-year average) still exists, and inventories are likely to exit the current heating season very near the five-year average.
With winter cold subsiding, demand for natural gas for heating and power-plant fuel will reduce. Further pressurizing the commodity is the rapid rise in the number of drilling rigs working in the U.S. (rig count has climbed 34% from a seven-year low reached last July) that signals a production increase later this year in the face of sluggish industrial demand.
Given the depressed state of the commodity, the in-line drop in reserves pulled down natural gas futures prices on the New York Mercantile Exchange (NYMEX). In particular, during the last few days, natural gas futures have fallen to a 12-week low, pressured by expectations of mild temperatures in the northern U.S.
There are concerns among traders that the market will be oversupplied as winter draws to a close, 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.
Therefore, we maintain our cautious stance on natural gas-focused E&P players such as XTO Energy (XTO), EOG Resources (EOG), Anadarko Petroleum Corp. (APC), EnCana Corp. (ECA) and Devon Energy Corp. (DVN).
Additionally, we remain skeptical on land drillers such as Nabors Industries (NBR) and Patterson-UTI Energy (PTEN), as well as natural gas-centric service providers such as Halliburton Company (HAL). 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 dayrates and margins well into the 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.
All the above-mentioned companies currently have Zacks #3 Ranks (Hold), meaning that these stocks are expected to perform relatively the same as the overall market during the next 1-3 months. Therefore, investors should maintain their current positions in the stocks over this time period.
Within the E&P group, we are positive on companies like Chesapeake Energy (CHK). With the bulk of its projected 2010 production hedged at attractive prices and with access to resource-rich assets, Chesapeake remains better positioned than most of its peers in this space. Our short-term recommendation on the stock is Buy (Zacks #2 Rank), meaning that Chesapeake is expected to outperform relative to the overall market during the next 1-3 months.
Read the full analyst report on “XTO”
Read the full analyst report on “EOG”
Read the full analyst report on “APC”
Read the full analyst report on “ECA”
Read the full analyst report on “DVN”
Read the full analyst report on “NBR”
Read the full analyst report on “PTEN”
Read the full analyst report on “HAL”
Read the full analyst report on “BP”
Read the full analyst report on “CHK”
Zacks Investment Research
