Natural Gas Supplies Expand Less - Analyst Blog

The federal government’s Energy Information Administration (EIA) reported a slightly lower-than-expected increase in natural gas supplies, reflecting warmer-than-normal temperatures, the deepwater drilling moratorium in the Gulf of Mexico (GoM), and the start of the hurricane season. 

Stockpiles held in underground storage in the lower 48 states rose by 87 billion cubic feet (Bcf) for the week ended June 11, 2010. The latest build was about 4% higher than the 5-year (2005-2009) average, though it was 23% short of the year-ago injection. 

The current storage level, at 2.54 trillion cubic feet (Tcf), exceeds last year’s level by 2 Bcf (0.1%) and remains 313 Bcf (14.0%) above the five-year average. Natural gas supplies have exceeded the 5-year average for this time of year in each of the past 12 weeks and still stand at record highs. 

Though the year-on-year storage surplus has declined (to almost flat levels) in recent weeks following a high of 101 Bcf for the week ending April 23, the specter of a continued glut in domestic gas supplies still exists, with storage levels remaining 14% above their five-year average. In fact, the latest build, though marginally below market expectations, has widened the massive overhang to the 5-year average. 

Further pressurizing the commodity is the rapid rise in the number of drilling rigs working in the U.S. (the natural gas rig count has climbed 42% from a seven-year low reached last July) that signals a supply glut later this year in the face of sluggish industrial activity.
 
More importantly, production from dense rock formations (shale) remains robust. In fact, the share of shale gas in the country’s natural gas production has shot up from zero to 8% in the last decade. This has created a massive oversupply, sending natural gas prices plummeting from $13 per million Btu (MMBtu) four years ago to just around $5.0 per MMBtu today (referring to Henry Hub spot prices). As there are more technological breakthroughs, shale gas has become viable in some cases at just $3 per MMBtu. 

There are concerns among traders that the market will be oversupplied in the short- to medium-term, with rig counts going up and industrial demand still struggling due to the weak economy. These factors translate into limited upside for natural gas-weighted companies and related support plays. 

The gap between supply and demand is expected to reverse in the coming months as natural gas producers bet on the improving U.S. economy, the forecast of an active hurricane season, and the recent moratorium on offshore GoM drilling. 

In particular, the uncertainty related to the huge oil spill accident in the GoM and the subsequent moratorium on offshore drilling in the region (at water depths of more than 500' through November 30, 2010) is expected to be positive for natural gas balances. Considering that more than 60% of the GoM gas production comes from the deepwater, we believe the drilling moratorium may reduce total domestic natural gas supply by 0.5% – 1% over the next few quarters. 

Until then, we maintain our cautious stance on natural gas-focused E&P players such as EOG Resources (EOG), Anadarko Petroleum Corp. (APC), Chesapeake Energy (CHK) and Devon Energy Corp. (DVN). 

Additionally, we remain skeptical on land drillers such as Nabors Industries (NBR), Patterson-UTI Energy (PTEN) and Helmerich & Payne (HP), as well as natural gas-centric service providers such as Halliburton Company (HAL). Although we expect the land rig count to continue with its steady rise during 2010, the large amount of excess capacity in the sector will weigh on day rates and margins well into the year. 

All the above-mentioned companies currently have Zacks #3 Ranks (Hold) rating, meaning that these stocks are expected to perform relatively at par with the overall market during the next 1-3 months. Therefore, investors should maintain their current positions in the stocks over this timeframe.
Read the full analyst report on "EOG"
Read the full analyst report on "APC"
Read the full analyst report on "CHK"
Read the full analyst report on "DVN"
Read the full analyst report on "NBR"
Read the full analyst report on "PTEN"
Read the full analyst report on "HP"
Read the full analyst report on "HAL"
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