Today's Nat Gas inventory report was disappointing to the market as the injection level came in above most all of the industry expectations (see below for a more detailed discussions of the inventory report). The market has been in selling mode since the inventory report was released not only because of the higher than expected injection level today but a slowly growing view that the underperformance we have seen in injections throughout the injection season this year may be starting to come to an end. In other worlds we could be getting closer to a point when injections start to outperform history and if that turns out to be the case the probability of storage hitting maximum capacity prematurely will be increasing.

On a positive note with Nat Gas prices declining again today the economic advantage of burning Nat Gas in place of coal wherever possible is increasing. The differential between the spot Nymex Appalachian coal and Nat Gas prices has now widened to $0.457/mmbtu in favor of Nat Gas. At this level utilities that have switched from coal to Nat Gas for power generation will continue to burn Nat Gas. If Nat Gas remains in the $2.25 to $2.50 trading range that I have been predicting we could even see more switching from Coal to Nat Gas as the industry becomes more convinced that the economic advantage of switching will remain in play for the medium term. This will help the demand side of the equation.

Today's EIA report was bearish from the perspective that the injection was above the consensus level but bullish when compared to last year and the five year injection levels. The EIA injection was 6 BCF above the consensus (56 BCF) but below last year's injection and below the injection level for the five year average for the same week. The net injection of 62 BCF was less than my model forecast (50 BCF) this week and within the range of consensus estimates. The inventory narrowed modestly versus both last year and the more normal five year average also. The current inventory level is now 687 BCF above the five year average.
This week's 62 BCF net injection is below last year's net injection of 81 BCF and below the injection level for the five year average of 99 BCF for the same week.

Working gas in storage was 2,877 Bcf as of Friday, June 1, 2012, according to EIA estimates. This represents a net increase of 62 Bcf from the previous week. Stocks were 713 Bcf higher than last year at this time and 687 Bcf above the 5-year average of 2,190 Bcf. In the East Region, stocks were 347 Bcf above the 5-year average following net injections of 38 Bcf. Stocks in the Producing Region were 249 Bcf above the 5-year average of 842 Bcf after a net injection of 11 Bcf. Stocks in the West Region were 91 Bcf above the 5-year average after a net addition of 13 Bcf. At 2,877 Bcf, total working gas is above the 5-year historical range.

Working gas stocks in the Producing Region, for the week ending June 1, 2012, totaled 1,091 Bcf, with 260 Bcf in salt cavern facilities and 831 Bcf in nonsalt cavern facilities. Working gas stocks decreased 1 Bcf in the salt cavern facilities and increased 12 Bcf in the nonsalt cavern facilities since May 25.

The overhang of total stocks versus last year narrowed once again versus last week and is now showing a surplus of 713 BCF or 32.9% above last year. All regions are still showing a surplus versus the five year average. Compared to the five year average for the same week the total stock level surplus narrowed to 687 BCF and sits at plus 31.4% above the same week for the five year average.

The following chart shows the difference between current total Nat Gas inventories compared to last year and the five year average. The direction has been a growing surplus in inventory since the end of August. However, the rate of growth of the surplus has been changing for most of the injection season as this year's injection season has been underperforming last year so far. The tide is turning as shown by this chart. However, as compared to last year total inventories are still showing a significant surplus of 713 BCF.
Let's look at the market from the inventory overhang perspective. So far 519 BCF of Nat Gas has been injected into inventory through the first twelve weeks of the injection season. Last year 706 BCF was injected during the first twelve weeks. This year is running at 73.5% of last year. Assuming (and this is a huge assumption) the rest of the injection season continues to run at 73.5% of last year's level than a total of 1,594 BCF will be injected this year versus last year's injection of 2,168 BCF. As long as the surplus continues to narrow the industry will be able to prolong hitting maximum storage capacity limitations. Through the first three months of the injection season the injections have pretty much been coming between 71 to 73% of last year.

The problem is injections are not going to continue to underperform unless there is an increase in consumption (possibly due to additional coal to gas switching and a hot summer) and/or a significant cut in production. As shown in the following table total inventories are now at 69.9% of maximum workable storage capacity with the Producing region at 80.7% of maximum. There will have to be a production cuts..sooner than later if the industry wants to avoid being prematurely shut out of storage capacity.
I am keeping my view at neutral and keeping my bias at neutral with an eye toward the upside now that Nat Gas has moved back to much more representative levels that are in sync with current fundamentals. The surplus is still narrowing in inventory versus both last year and the five year average but could lead to a premature filling of storage during the current injection season. However, I now believe that we may see other producers starting to signal a cut in production. We may still see lower prices (thus the basis for my bias) but I think the sellers are losing momentum.
With what is looking like a transition toward more stimulus/easing programs starting to surface around the world I am upgrading my oil view to neutral with one eye toward the bullish side. I am starting to expect the oil complex to settle into the $80 to $90/bbl trading range basis WTI and $95 to $105/bbl basis Brent. At the moment it is not so much that the current fundamentals have changed it is more related to the fact that the market sentiment is changing as participants move into the perception mode based on more stimulus which could result in an improvement of the forward fundamentals from a demand perspective.

Talk of stimulus combined with an election in the US that the market interpreted as possibly the beginning of what could be a change in politics this year both acted as the catalysts participants were looking for to kick off the strongest short covering rally this year. In the US it was the single biggest one day gain in equities for the year. All risk asset markets have been in an oversold state for weeks and yesterday's turn in sentiment was enough to send a lot of shorts to the sidelines. I would not say that the underlying trend for oil, commodities or equities has changed as the conditions that have pushed all of the risk asset markets into a downtrend has not changed. So for the moment was can categorize yesterday's rally as simply a short covering rally and one that is once again getting energized after China just lowered interest rates.

Today China announced a cut in its short term interest rates as it attempts to jump start the main economic and oil consumption growth engine of the world. China cut its short term rate by 25 basis points. This is another positive that should keep equity and commodity markets steady for another day. The perception that a more aggressive easing of monetary policy in China could act as a floor in risk asset prices going forward and it could also be an early warning signal that both the US and EU will actually move forward with more stimulus programs.

As we have discussed on numerous occasions June is event month with many situations that can be market moving events or at least perceived to be market moving events. For example although the ECB kept interest rates steady at the meeting yesterday the head of the ECB did make a comment during his presser saying the ECB will act if necessary as the growth outlook dims. The market interpreted that comment as meaning that the ECB may be close to some form of a stimulus plan. We are clearly in the perception stage and for the moment it has kept markets in Europe stable after yesterday's short covering rally. Today in the US Federal Reserve Chairman Bernanke will be testifying before Congress with the market listening carefully to his every word to see if he signals his intentions for the upcoming FOMC meeting at the end of June. The market is looking for any indication that the US Fed may be leaning toward some form of a QE3.

In the last twenty four hours the global markets have moved from everything bearish to the perception that the world's central banks are starting to get it together and do what they can from a momentary policy perspective to jump start the global economy. The recent announcement by China has turned oil and other commodity prices back into positive territory for the day. I would expect another day of short covering especially if Bernanke gives any indication of his intentions during today's Congressional testimony. We may be at the early stages of moving from the perception of more stimulus to reality now that China has cut short term interest rates. The world is once again in a mode of trying to inflate their way out of the slow growth pattern of the global economy.

Currently markets are mixed as shown in the following table.
Best regards,
Dominick A. Chirichella
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