Musings: What Glut? Oops, Maybe There Is A Glut After All

For weeks the talk in the investment world and the energy business was what would happen when the glut of natural gas rendered winter storage no longer an option.  The debate focused on what would happen to the surge in natural gas production if we completely filled the nation’s available storage capacity before the start of the heating season.  How would producers handle involuntary well shut-ins?  What would happen to the price of natural gas – would it be like some periods in recent memory in which Rocky Mountain gas sold for pennies? 

How would producers handle involuntary well shut-ins?

But then an amazing thing happened.  The Energy Information Administration’s (EIA) weekly gas storage report for the week ending September 4th came out showing that producers had injected only 69 billion cubic feet (Bcf).  The gas futures market took off.  Gas injection volumes for the week were below the average expected by analysts and traders on Wall Street.  The problem was that no one was exactly sure how much better the injection number really was.  We saw three reports comparing the 69 Bcf injection figure with the supposed estimate.  Those estimates were 71 Bcf, 72 Bcf and 73-75 Bcf.  So why did the market react to this particular shortfall surprise when it hadn’t reacted to some previous ones?  We have to think it had to do somewhat with what was happening to crude oil prices, the positive mood coming from the Barclays’ energy conference and investors clamoring to get in on the “trade of the year” – the record wide disparity in the oil/natural gas price. 

Gas injection volumes for the week were below the average expected by analysts and traders on Wall Street

As the chart from the NYMEX on Friday afternoon shows, natural gas futures prices were recovering slowly during the first two and a half days of last week’s trading before the EIA inventory numbers were released.  Then, gas futures prices soared through the $3 per thousand cubic feet (Mcf) level and up close to $3.30.  For the day, gas prices surged 15%, the largest rise in nearly five years.  We suspect that when gas prices couldn’t break through a technical price level on Friday, just as happened to oil prices, the profit-taking mantra for traders came into play. 

Exhibit1"

Suddenly the more important considerations in the trading pits became the growing volume of gas in storage and the lack of gas demand.  We are still weeks away from the start of the heating season.  So far the hurricane outlook for the Gulf of Mexico has been benign.  And lastly, the economy may have stopped going down, but it is not showing many signs of growth.  Lurking in the background is concern that we might experience a warm winter.

Exhibit2"

As the accompanying chart taken from the closing data on the NYMEX web site last Friday shows, the outlook for winter natural gas prices remains very healthy compared to the current (Oct-09) futures price.  With gas prices over $5 per Mcf in the early months of 2010, the incentive for producers to cut back their gas drilling doesn’t exist as long as they can continue to tap these higher future prices through hedging contracts and that they can deliver the gas when it is needed. 

With gas prices over $5 per Mcf in the early months of 2010, the incentive for producers to cut back their gas drilling doesn’t exist

Producers continue to demonstrate how good they are at growing their gas production, something that Wall Street continues to reward with higher stock prices.  The nearby chart from the recent investor

Exhibit3"

presentation by Chesapeake Energy (CHK-NYSE) shows the top 20 domestic gas producers and their 2009 1st and 2nd quarter gas production volumes along with their 2008 2nd quarter volumes.  An interesting observation is that of the 12 largest producers, only five showed sequential gas production growth in the recent 2nd quarter.  However, if one includes those companies with less than a 1% decline, you add two more to the count, and one could argue that the 1.1% decline of ConocoPhillips (COP-NYSE) is immaterial, adding one more to the total.  Some 2/3rds of the dozen largest producers would have either flat or higher gas production after more than half a year of a dramatic cutback in gas-oriented drilling. 

2/3rds of the dozen largest producers had either flat or higher gas production after more than half a year of a dramatic cutback in gas-oriented drilling

The bottom line is that conditions are still not ripe for a significant retrenchment in natural gas supplies and until either a severe cold snap hits the nation or our economy demonstrates a “V” recovery pattern, natural gas will be bogged down in a disappointing pricing environment.

G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.

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