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Natural Gas Falls to Lowest Since 2016: Has it Bottomed Out?

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The U.S. Energy Department's weekly inventory release showed a larger-than-expected decrease in natural gas supplies. However, the positive sentiment was overwhelmed by mild winter weather forecasts amid strong production, which led prices to trickle down to their lowest level in more than three and a half years.

Drawdown Beat Estimates but Storage Remain Well Above 5-Year Average

Stockpiles held in underground storage in the lower 48 states fell by 109 billion cubic feet (Bcf) for the week ended Jan 10, above the guidance (of 92 Bcf fall). The decrease was also higher than last year’s drop of 82 Bcf but came below the five-year (2015-2019) average net shrinkage of 184 Bcf for the reported week.

The latest withdrawal puts total natural gas stocks at 3.039 trillion cubic feet (Tcf) - 494 Bcf (19.4%) above 2019 levels at this time and 149 Bcf (5.2%) over the five-year average.

Fundamentally speaking, total supply of natural gas averaged 99.1 Bcf per day, down 1.3% on a weekly basis due to lower shipments from Canada even as dry production remained essentially unchanged.

Meanwhile, daily consumption fell 2.2% to 111.5 Bcf compared to 114 Bcf in the previous week primarily due to weaker demand from the power and residential/commercial sectors.

Futures Log Heavy Losses

The natural gas futures market ignored the larger-than-expected decline in U.S. supplies, with the commodity posting a 9% weekly loss. In fact, futures for February delivery traded to the lowest level since May 2016 after weather updates showed milder temperatures and pessimistic signs for heating demand over the next few days. No wonder, then, that natural gas – at $2.003 per MMBtu – is down more than a dollar from where they were last year. For a while, the commodity even dipped below the psychologically important level of $2 on Friday.

What’s Behind Natural Gas’ Price Collapse?

No major commodity had a worse 2019 than natural gas. The fuel endured a torrid year, registering its worst annual decline since 2014. Prices tumbled more than 25% last year, falling to multi-year lows of around $2.1 per MMBtu in between, as buyers fled the market over growing worries about record output and concerns of an ongoing supply glut.

The demand for cleaner fuels and the commodity’s relatively lower price has catapulted natural gas' share of domestic electricity generation to 37%, from 25% in 2011. Moreover, new pipelines to Mexico, together with large-scale liquefied gas export facilities have meant that exports out of the U.S. are set for a quantum leap. Finally, higher consumption from industrial projects will likely ensure strong natural gas demand.  

But thanks to soaring shale output, the United States has been the world's largest natural gas producer since 2009. Higher recovery rates from major unconventional fields have helped unleash record volumes regularly. As a matter of fact, the EIA forecasts that the United States is likely to have produced 92.1 billion cubic feet a day (Bcf/d) of dry natural gas in 2019, up from the 2018 average of 83.4 Bcf/d - a record high for the second consecutive year. The agency also projected that domestic gas output would rise to an all-time high of 95.1 Bcf/d in 2020. In other words, record high production in the United States and expectations for healthy growth through 2020 means that supply will keep pace with demand.

Brace for a Wild Ride on the Up and the Downside

Natural gas might experience short-lived surge based on positive weather forecasts but any powerful turnaround looks unlikely at the moment. With output from shale formations swamping the market, there is little room for prices to improve meaningfully from their current levels.

True, shale production growth is expected to slow this year but prices are unlikely to eclipse the $3 threshold on a sustainable basis, if at all, as upstream players will look to add volumes as prices improve.

The bearish natural gas fundamentals and its seasonal nature is responsible for the understandable reluctance on investors’ part to dip their feet into these stocks. In fact, most gas-focused names took a pounding during the past year. Shares of EQT Corporation EQT, Montage Resources Corporation MR, Gulfport Energy Corporation GPOR, Southwestern Energy Company (SWN - Free Report) etc. – all carrying a Zacks Rank #3 (Hold) – have fallen somewhere between 40% and 65% over the past 12 months. Some like Cabot Oil & Gas Corporation COG is further down the pecking order, with a Zacks Rank #5 (Strong Sell).

If you are still looking for near-term natural gas play, SilverBow Resources, Inc. SBOW might be an excellent selection. The Houston, TX-based company – with a Zacks Rank #1 (Strong Buy) – has seen the Zacks Consensus Estimate for 2020 rise 6.8% over 60 days.

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