Supply Glut Pressuring Natural Gas - Analyst Blog

In its weekly release yesterday, the Energy Information Administration (EIA) reported a bigger-than-expected 54 billion cubic feet (Bcf) weekly addition to natural gas stockpiles for the week ended August 21. This takes the current storage level to 3.26 trillion cubic feet (Tcf), which is up 18.8% from last year’s level and 18.1% above the five-year range (as clear from the nearby chart from the EIA). Current stocks are 516 Bcf above this last year and 500 Bcf above the five-year average.

The build was smaller than last year’s 100 Bcf build and the five-year-average injection of 67 Bcf. However, the relentless increase in gas storage levels continue to add to the long list of issues weighing on the commodity. Natural gas prices rallied earlier last year, reaching over $13 per million Btu (MMBtu) in July 2008, before trending down. Prices have since dropped sharply to the current seven-year low level of sub-$3 per MMBtu (we are referring to Henry Hub spot prices here).

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. The supply picture is expected to reverse in the coming months as the lagging effect of the sharp drop in domestic drilling activity takes effect. Partly offsetting the production drop is the expected ramp-up of LNG imports this year.

The commodity’s weak near-term outlook, coupled with the ongoing credit market turmoil, has prompted natural gas producers to curtail capital expenditure plans for 2009. As a result, this has been an extremely difficult period for natural gas and related energy support plays.

Considering the plunge in the commodity prices, we remain cautious on natural gas-focused E&P players such as XTO Energy (XTO), Chesapeake Energy (CHK), EOG Resources (EOG) and EnCana Corp. (ECA). We currently rate shares of these companies as Neutral.