Sunday, February 27, 2011

Natural Gas: Weekly Storage Analysis and More

Natural gas inventories declined by 81 bcf for the week ended Feb 18. Near record temperatures observed in the northeast during the latter part of the week saw demand for natural gas weaken during the reporting period.

The 81 bcf draw compares to a draw of 233 bcf in the previous week. The same period last year saw a decline of 175 bcf, while the 5-year average is decline of 149 bcf.

Total working gas in storage now stands at 1,830 bcf, 48 bcf less that where we were at this point last year, and 61 bcf below the 5-year average. 

While inventory levels remain healthy, it's a refreshing change to see inventory levels no longer nearing or making new record highs. Part of the credit certainly goes to the cold winter we've experienced so far this year. I'll need to do some additional research to see what other factors may be impacting the supply/demand balance, but there are some signs that industrial demand may finally be picking up a little.

And while natural gas prices still remain stubbornly near multi-year lows, there are a number of fundamental factors in favour of the bulls:
  1. Market sentiment remains solidly bearish.
  2. All things being equal, triple-digit oil prices make current natural gas look cheap on an equivalent-BTU basis. 
  3. Inventory levels are no longer at record high levels.
  4. The 2011 Hurricane Season is only 3 short months away, and early forecasts are calling for a 40% increase in Atlantic hurricane activity vs. the norm. See Tropical Storm Risk for the full forecast.
  5. Longer term, the possible role that natural gas might play in North America's energy plan needs to be considered.
  6. Finally, look at natural gas names like ECA, HK, DVN, CHK, SWN, RRC. All of these stocks have been rallying even as natural gas prices are near recent lows. That alone tells me we are not going to see a 2-handle on natural gas prices as some are predicting.   
The biggest thing going for the bears (and it's a big one) is supply. Shale gas has changed the supply/demand dynamics in North America for the indefinite future. But that at some point you have to think that this supply has been priced into the market. And with environmental concerns, higher shale depletion rates vs. conventional wells, and the fact that many of these shale plays are simply not economic at prices under $6/mmBTU, the recent supply of shale gas we've become accustomed to could begin to slow in the near future.

Technically, the natural gas contract put in a big reversal off the lows on Friday. And the fact that natural gas was unable to sustain any kind of move lower after the -81 bcf release on Thursday has to be looked at as bullish. From a risk/reward perspective, I like the idea of playing natural gas from the long side over the next couple of months as long as last week's low holds.

I remain long HNU.TO from 4.92 and HK from 20.45. I took some profits on 25-30% of these positions on Friday to reduce the risk a little and improve my average, but I think the chances are good they both see much higher prices over the next couple of months. I also particularly like DVN and may look to initiate a position in the 88-89 area if I get a chance this week.

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