Nat Gas futures are starting the day with only a minor level of profit taking selling so far and are holding onto most of the gains from the last two sessions. The current price is at the upper end of the trading range and at a level that I still do not think is sustainable. At the current price level coal to Nat Gas switching is now favorable to coal which if the price remains at the current level utilities will have to look seriously at switching back to coal. In addition the latest NOAA six to ten day and eight to fourteen day forecasts are not going to result in much if any cooling or early heating related demand. As I have been indicating for the last week or so the current fundamentals do not support Nat Gas futures prices at current levels.

I know it is a stretch but the market could be stating to trade Nat Gas based on the perception that once the industry gets through the shoulder season if the winter is much more normal (than last year) or colder than normal there is still a possibility for a rally in prices toward the end of the year and into early next year. As I said at this point that view is a stretch as it is way too early to get comfortable with any winter weather projections. I am still expecting a downside correction to hit the market at some point... not likely until after this week's lower than normal injection is digested by the market. I also expect prices to remain in a trading range of $2.50-2.60/mmbtu to $3 to $3.10/mmbtu for the majority of the shoulder season.

One thing for certain the industry does not have to worry anymore about filling storage facilities prematurely as the EIA announced today that the demonstrated peak working gas capacity for U.S. underground working natural gas storage for the Lower 48 states rose by 3 percent, or 136 billion cubic feet (Bcf), between April 2011 and April 2012. It then totaled 4,239 Bcf. Most of the increase came in the form of more use of traditional storage in the West (56 Bcf) and salt cavern storage in the Producing region (58 Bcf). Salt cavern storage allows rapid injection and withdrawal to respond to market conditions and other short-term events. Demonstrated peak working natural gas in the East rose by only 14 Bcf (less than 1 percent), but this small increase coincided with the rapid growth of production from the Marcellus Shale.

The EIA released their latest Short Term Energy Outlook (STEO) yesterday afternoon. Following are the main Nat Gas related highlights from this report.

  •  EIA expects that natural gas consumption will average 69.8 billion cubic feet per day (Bcf/d) in 2012, an increase of 3.2 Bcf/d (4.8 percent) from 2011. Large gains in electric power use in 2012 more than offset declines in residential and commercial use. Projected consumption of natural gas in the electric power sector averages 25.2 Bcf/d in 2012, 21 percent higher than in 2011, primarily driven by the improved relative cost advantages of natural gas over coal for power generation in some regions. Consumption in the electric power sector during 2012 peaks at 31.1 Bcf/d in the third quarter, when electricity demand for air conditioning is highest.
  •  Total natural gas consumption increases by 0.2 Bcf/d (0.2 percent) in 2013. Expected increases in residential, commercial, and industrial consumption offset expected declines in the electric power sector. A forecast of near-normal weather during the upcoming winter drives 2013 increases in residential and commercial consumption of 9.9 percent and 9.3 percent, respectively. Although higher natural gas prices contribute to an 8.4 percent decline in forecast natural gas consumption in the electric power sector in 2013, consumption in the power sector next year is still expected to be about 2.3 Bcf/d higher than 2011 levels.
  •  Total marketed production of natural gas grew by 4.8 Bcf/d (7.9 percent) in 2011. This strong growth was driven in large part by increases in shale gas production. EIA expects continued year-over-year growth in 2012 of 2.6 Bcf/d. EIA, however, expects a small drop in production in the coming months, reflecting both losses from hurricanes and declines related to recent drops in the rig count. Hurricane Isaac hit the Gulf of Mexico on August 28 and has affected natural gas production for several days, with shut-ins in the Gulf of Mexico totaling 27.9 Bcf through September 10. According to Baker Hughes, the natural gas rig count was 452 as of September 7, 2012, compared with 811 at the start of 2012.
  •  EIA forecasts that production growth will slow to 0.5 Bcf/d in 2013, as the slowdown in drilling activity is offset by growth in production from liquids-rich natural gas production areas such as the Eagle Ford and wet areas of the Marcellus Shale, and associated gas from the growth in domestic crude oil production.
  •  Working natural gas inventories remain at historically high levels for this time of year. As of August 31, 2012, according to EIA's Weekly Natural Gas Storage Report, working inventories totaled 3,402 Bcf, which is 395 Bcf greater than last year's level and 329 Bcf above the five-year average. EIA expects that inventory levels at the end of October 2012 will set a new record of 3,950 Bcf. Because of very high inventories at the start of the summer injection season this year, working inventories have remained high and stock builds since April, with a few exceptions, have been below the five-year average and below last year's levels. The projected increase of 1,473 Bcf in working gas inventory during the 2012 injection season (from the end of March to the end of October) would be the smallest build since 1991.

The recovery from the preemptive shut-ins ahead of hurricane Isaac continues and are almost complete. As of yesterday afternoon there is now just 57,439 bpd or 4.16% of GOM crude oil production shut in and just 213 mmcf/d or 4.73% of GOM Nat Gas production shut down. The industry will be at normal operating levels in the next day or so. This is the end of the coverage of the GOM situation by the BSEE.

At the moment there is nothing in the near term coming from the tropics that is a threat to the energy operations in the Gulf of Mexico or US land for that matter. There is a tropical weather pattern located in the central Atlantic between the Cape Verde Islands and the Lesser Antilles that is showing signs of organization. At the moment this pattern has been upgraded to TD14 and is projected to move west then north into the North Atlantic. At the moment this pattern does not look like it will be anything that threatens the US.

This week the EIA will release the weekly Nat Gas inventory report on its normal schedule... Thursday, August 23 at 10:30 AM. This week I am projecting a 35 BCF net injection into inventory. My projection for this week is shown in the following table and is based on a week that experienced minimal Nat Gas cooling related demand but a loss of GOM supply from Isaac (but not as much as last week's report period. My injection forecast is based on the fact that a lower percentage of the US experienced above normal temperatures. My projection compares to last year's net injection of 80 BCF and the normal five year net injection for the same week of 72 BCF. Bottom line the inventory surplus will narrow and underperform strongly this week versus last year and the five year average and more than what has been occurring for most of the season. In fact this week's underperformance will be at 43% of last year if the actual outcome is in sync with my forecast. For interest the average for the injection season to date has been around 73% of last year.
If the actual EIA data is in line with my projections the year over year surplus will narrow to around 350 BCF. The surplus versus the five year average for the same week will narrow to around 292 BCF. This will be a bullish weekly fundamental snapshot if the actual data is in line with my projection. The very early industry projections are coming in a range calling for an injection of 22 to 40 BCF.

Today Germany's Federal Constitutional Court ruled in favor of Germany's participation in the European Stability Mechanism (ESM) with a cap of 190 billion Euros. The ESM a permanent 500 billion euro fund that offers loans to member states. The ESM may also buy bonds to lower member country borrowing costs. Germany will be the largest contributor to the fund with a 27% share. This ruling is certainly a key element for the ECB program announced last week by Mr. Draghi and now opens the door for the ECB to begin to act.

The next big event on the docket is tomorrow's FOMC meeting announcement. The market has been pricing in some additional easing by the Fed. In fact the market may be setting up for a downside correction irrespective of the outcome. If the Fed announces a new QE3 program the market could be in a buy the rumor sell the fact mode and thus result in a downside correction. On the other hand if the Fed pushes the decision down the road (my likely outcome) we could also see a downside correction in risk asset markets. Irrespective of the outcome the next several days are likely to be volatile with the potential for intraday price reversals.

I am keeping my view at neutral as the industry is already almost back to normal operations after Isaac. At current prices the economics still favor Nat Gas but if prices do work their way to the upper end of the trading range utilities could begin to move back to coal.
I still think the oil price is overvalued and toppy at current levels as it approaches a key technical resistance area. WTI is still currently in a $90 to $100/bbl trading range while Brent is in a $110 to $120 trading range. That said prices are being impacted by a combination of last week's inventory report as well as by the outcome of the ECB meeting and the growing view that more stimulus from both China and the US is on the way.

Markets are mixed as shown in the following table.
Best regards,
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy

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