Natural Gas Starts to Build

The federal government’s Energy Information Administration (EIA) reported an in-line increase in natural gas supplies. Stockpiles held in underground storage in the lower 48 states rose by 11 billion cubic feet (Bcf) for the week ended Mar. 19, 2010.

The current storage level, at 1.63 trillion cubic feet (Tcf), is down 1.7% from last year's level but remains 8.0% above the five-year range (as clear from the following chart from the EIA). Current stocks are 28 Bcf below last year’s level and 121 Bcf above the five-year average.

Working Gas in Underground Storage Compared with 5-Year Range



Note: The shaded area indicates the range between the historical minimum and maximum values for the weekly series from 2005 through 2009.

Source: Form EIA-912, "Weekly Underground Natural Gas Storage Report." The dashed vertical lines indicate current and year-ago weekly periods.

The injection was the first of the year and comes after 15 consecutive weeks of inventory decline. During this time, natural gas stockpiles fell significantly from the all-time high level of 3.84 trillion cubic feet (Tcf) reached in late Nov. last year, reflecting a steady bout of cold weather that kicked up demand in major gas-consuming regions in the U.S.

Stockpiles went on to create new highs in 2009 as the economic downturn ate into demand, and natural-gas producers continued to unlock new supplies from onshore natural gas fields known as shales.

However, the three-month cold snap (from Dec. ‘09 through Feb. ’10) led to a surge in the commodity’s demand, in the process erasing a hefty surplus over last year’s inventory level and significantly trimming the excess over the five-year average level.

As a result of the sustained inventory drawdown, the commodity staged a phenomenal recovery, breaching the $5.70 per million Btu (MMBtu) level during early Feb. 2010 (referring to Henry Hub spot prices), up significantly from the 7-year-low level of sub-$2 per MMBtu in Sept. 2009. Things appeared to be getting better for the natural gas players, with cold weather slowly cleaning up the storage surplus.

But mild weather in March has considerably curtailed heating demand, as reflected by the latest EIA release that showed an 11 Bcf injection in natural gas stocks. This has fueled concerns that inventories are likely to exit the current heating season (Nov. through Mar.) higher than the five-year average. Already, warmer spring weather appears to have arrived in the U.S. Midwest and Northeast.

Further pressurizing the commodity is the rapid rise in the number of drilling rigs working in the U.S. (natural gas rig count has climbed 41% from a seven-year low reached last July) that signals a supply glut later this year in the face of sluggish industrial demand. Meanwhile, production from dense rock formations (shale) remains robust.

Given the depressed state of the commodity, natural gas prices have dropped to their lowest levels in six months, currently trading below $4.00 per MMBtu.

There are concerns among traders that the market will be oversupplied as winter draws to a close, 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.

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

Additionally, we remain skeptical on land drillers such as Nabors Industries (NBR - Analyst Report) and Patterson-UTI Energy (PTEN - Analyst Report), as well as natural gas-centric service providers such as Halliburton Company (HAL - Analyst Report). 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 dayrates and margins well into the year.

Oil majors like BP Plc (BP - Analyst Report) that have significant natural gas operations are also expected to remain under pressure until pricing and demand improve further.

All the above-mentioned companies currently have Zacks #3 Ranks (Hold), meaning that these stocks are expected to perform relatively the same as the overall market during the next 1-3 months. Therefore, investors should maintain their current positions in the stocks over this time period.

Read the full analyst report on XTO

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 HAL

Read the full analyst report on BP