US gas market a two-headed llama?

Well, so much for the idea of a $5/Mcf price floor for natural gas this year. But don't start taking bets on $2-3/Mcf just yet.

While some may have panicked when US composite spot gas prices dipped to the year's low of $4.52/Mcf for the week ended Aug. 1, that panic was premature. By the end of the following week, spot prices had topped $5/Mcf. The price rise stemmed largely from a US Department of Energy report that injection into storage had totaled a mere 74 bcf. That was a continuation of several weeks of slackening from what has been a torrid pace throughout much of the injection season. But the bulls' resulting glee may be a bit premature as well.

There are a number of conflicting factors at work in US gas markets today, much like Dr. Doolittle's fabled pushmepullyou animal. This whimsically fictitious, llamalike creature had head and forequarters at both ends and thus was a bit of a failure as a beast of burden: No matter which way you wanted it to go, it always felt compelled to also go in the opposite direction as well. (Great for simultaneous foresight and hindsight, however.) So the countervailing forces of supply and demand are like a pack of pushmepullyous, always ready to go in opposite directions at once.

Storage

There are several factors contributing to the general uncertainty over the direction of natural gas storage injection. They too push and pull in opposite directions at once. The falloff in storage injection at the first of the month came amid indications of increased fuel-switching to gas from oil, a return to more-normal temperatures, and a consequent surge in US electricity demand of 2%.

Ron Denhardt, with Strategic Energy & Economic Research Inc., suggested that the 74 bcf injection indicated that 1-1.5 bcfd of demand had returned as a result of lower gas prices.

So is natural gas recapturing lost market share, making the bulls happy? Not so fast, say Morgan Keegan & Co. Inc. analysts Subash Chandra and John W. Staples. They noted that the latest surprise in low storage injection levels stemmed entirely from lower-than-recent injections in the so-called producing region. In the net consuming eastern region, injections at 58 bcf were high.

"If there was fuel-switching, why did it not show up in a major consuming center?" the Morgan Keegan analysts asked in an Aug. 8 research note. "Producing region injections are driven by factors other than demand, such as cash/futures relationships. We don't know what happened yet, but there is enough (market) 'noise' to be skeptical of the market-share theory."

Such an anomaly tends to make the bears happy.

Fuel-switching

On the other hand, gas prices recently have been trading at a discount to distillates, points out Ron Barone of UBS Warburg LLC. And the natural gas premium to residual fuel oil continues to narrow.

"We note that these distillate/resid prices do not include the incremental cost of emission credits and/or taxes, thus making natural gas price even more attractive," he said.

Furthermore, while the year-on-year storage deficit has fallen sharply in recent months, it nevertheless remained 234 bcf below the previous 5 year average with the latest injection report. Barone estimates industry will need to inject 9.8 bcfd to get storage to the magic 3 tcf level by the start of the heating season Nov. 1—which he expects will occur.

Let's not forget the weather. Forecasters are calling for the busiest hurricane season in years, with the likelihood of several major hurricanes—which always disrupt production. The near-term outlook is for a continuation of excessive heat in the West, cooler-than-normal conditions in the East, and normal temperatures in the South and Southeast (of course, "normal" summer temperatures in the South can be pretty miserable for many of us who live there). Another pushmepullyou.

Further out, the National Weather Service has noted the rapid dissipation of the La Nina phenomenon, which augurs for more-normal (read: colder) temperatures this winter in the East but warmer-than-normal weather in the Midwest. Yet A.G. Edwards & Sons Inc.'s Bill O'Grady notes in the NWS forecast a prediction for a warm Alaska, which usually is a harbinger of a very cold Northeast winter. That offers support for gas prices.

Bulls and bears and pushmepullyous, oh my.

Time to remember another mythical animal: the phoenix, arisen from the ashes—like the $2/Mcf gas market of just a few seasons ago.

(Author's e-mail: [email protected])

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Latest Prices as of Aug. 8, 2003