Natural Gas Rises to 13-Week High on Outlook for Warm Weather
Comment of the Day

May 18 2012

Commentary by Eoin Treacy

Natural Gas Rises to 13-Week High on Outlook for Warm Weather

This article by Naureen S. Malik may be of interest to subscribers. Here is a section:
“We remain concerned that the price and sentiment are running ahead of the actual progress” in reducing a surplus of 773 billion cubic feet, Tim Evans, an energy analyst at Citi Futures Perspective in New York, said in a note to clients today. “Among the issues, a further rally runs the risk of power utilities switching back to coal, undercutting demand.”

Gas prices above $2.50 may be enough to prompt some generators to burn more coal and less natural gas, Chris Kostas, senior power and gas analyst for Energy Security Analysis Inc. in Andover, Massachusetts, said yesterday.

The Energy Department forecast this month that power generators will consume 21 percent more natural gas this year compared with 2011 because of the drop in the fuel's price.

Some producers, including Chesapeake Energy Corp. and Encana Corp., have responded to lower prices by announcing production cuts this year. More will need to be made “sooner than later as the industry avoids being prematurely shut out of storage capacity,” Dominick Chirichella, senior partner at the Energy Management Institute in New York, said in a note to clients yesterday.

Marketed gas production may climb 4.4 percent this year from a record 66.22 billion in 2011, the Energy Department said May 8 in its Short-Term Energy Outlook.

Eoin Treacy's view We have described the revolution in unconventional natural gas production as a game changer for the energy sector for a number of years and this is no less the case today. The absence of an export outlet coupled with excess supply has contributed to depressed pricing in US natural gas. The mild winter was an additional factor which contributed to prices halving in the six months from September. However this decline masks some of the important changes occurring in the sector.

A great deal of unconventional supply is uneconomic below $4 so as prices declined the incentive to drill decreased. Concurrently, the high price of oil proved alluring for unconventional oil drilling which attracted drills from the pure natural gas sector. When the price of any commodity declines new sources of demand emerge. Natural gas became competitive with coal as prices declined which, coupled with the pressure power companies are under from new environmental legislation, increased demand. Recent warm weather was an additional bullish consideration.

Traders have had the contango on their side and have either shorted the nearby months or participated via the oil/natural gas ratio in an effort to benefit from natural gas's downward momentum. Natural gas found support in the region $2 from late April and have rallied, while oil prices have been falling rather quickly over the last couple of weeks. This has put both shorting strategies under pressure and the size of natural gas's rally to date suggests short covering.

Natural gas prices will need to find support above $2 on the next significant pullback to confirm a return to medium-term demand dominance, but in the meantime a sustained move below $2.38 would be required to question potential for additional upside.

The Coal/Natural gas ratio is also contracting rapidly which should be a net positive for the coal mining sector. However, as pointed out in the above piece industrial commodity shares have been among the hardest hit during the current corrective phase. In fact of the 24 global coal shares in my Favourites only Philippines listed Semirara Mining (4.8%) has been unaffected by the recent selling pressure. 19 are making at least new 6-month lows. The Market Vectors Coal ETF broke below $30 two weeks ago and continues to extend the decline. While becoming increasingly oversold in the short-term a clear upward dynamic would be required to check momentum beyond a brief pause. (Also see Comment of the Day on May 9th).

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