Natural Gas Builds at Slower Pace

Yesterday, we received a mildly positive report from the federal government’s Energy Information Administration (EIA), showing a less-than-expected rise in natural gas supplies. Stockpiles held in underground storage in the lower 48 states rose by 66 billion cubic feet (Bcf) for the week ended September 11.

This takes the current storage level to 3.46 trillion cubic feet (Tcf), which is up 16.7% from last year's level and 16.4% above the five-year range (as clear from the nearby chart from the EIA). Current stocks are 496 Bcf above last year’s level and 487 Bcf above the five-year average. The inventory addition was lower than the five-year-average injection of 82 Bcf but slightly exceeded last year's build of 65 Bcf.
 

 
Overall, the relentless increase in gas storage levels continue to add to the long list of issues weighing on the commodity. At this pace, inventories are on course to surpass the all-time high level of 3.57 Tcf recorded at the end of October 2007.

Natural gas prices rallied earlier last year, reaching over $13 per million Btu (MMBtu) in July 2008, before trending down to seven-year low level of sub-$2 per MMBtu (we are referring to Henry Hub spot prices here).

Continued strong domestic production (from a number of unconventional natural gas fields) and recessionary consumption (due to the economic downturn), particularly in the industrial sector, are at the core of the commodity's current woes. Additionally, the Atlantic hurricane season has done little to disrupt offshore production and onshore refineries.

However, prices have rebounded somewhat over the past two weeks, currently settling at well over $3 per MMBtu, helped by back-to-back bullish storage data from the EIA as well as indications of an uptick in industrial production levels. But with U.S. natural gas storage levels still remaining 16% above their five-year average, we do not see any sustained price gains on the commodity front. This translates into limited upside for natural gas weighted companies and related support plays.

As a result, we remain cautious on natural gas-focused E&P players such as XTO Energy (XTO - Analyst Report), Chesapeake Energy (CHK - Analyst Report), EOG Resources (EOG - Analyst Report), Devon Energy Corp. (DVN - Analyst Report) and EnCana Corp. (ECA - Analyst Report). We currently rate shares of these companies as Neutral.

We also maintain our Neutral recommendations for land drillers such Nabors Industries (NBR - Analyst Report) and Patterson-UTI Energy (PTEN - Analyst Report), as well as natural gas-centric service providers such as BJ Services (BJS - Analyst Report), given the extent of excess capacity in the sector that is expected to weigh on dayrates and margins well into next year.