Natural Gas Feint Means Prices Poised to Plummet 19% on Storage

By Reg Curren

Sept. 28 (Bloomberg) — The steepest rally in natural gas prices since 2006 is coming to an end as the 400 salt caverns, depleted oil fields and aquifers used to store the fuel in the U.S. reach capacity for the first time.

Stockpiles may surpass the record of 3.545 trillion cubic feet by as much as 350 billion cubic feet this fall, Energy Department estimates show. Gulf South Pipeline Co. says its fields in Louisiana and Mississippi are so full that customers will have to pay penalties for exceeding their limits. With no place to go, producers will be forced to dump excess fuel on the market.

The worst economic slump since the 1930s will cut demand from chemical plants to carmakers to households by 2.4 percent this year, according to government estimates. The November futures contract will drop about 19 percent to near $4 per million British thermal units, said Stephen Schork, president of consultant Schork Group Inc. in Villanova, Pennsylvania.

“I don’t know where all of this gas is going to go,” said Schork, a former natural gas trader on the New York Mercantile Exchange, who in June forecast inventories would reach near 3.8 trillion cubic feet. “We’re a month away from significant heating demand. Something’s got to give.”

The November contract has climbed 35 percent from its low of $3.662 per million Btu on Sept. 3 to $4.948 on Sept. 25 after economic reports signaled that the recession is ending and fuel demand will rebound in 2010. October futures, which expire today, have risen 59 percent from a seven-year low of $2.508 in the same period.

Awaiting Rebound

Employers cut fewer jobs than expected in August, a report from the Labor Department on Sept. 4 showed. Output at factories, mines and utilities climbed 0.8 percent, in August, according to the Federal Reserve. The economy will probably expand 2.9 percent this quarter and 2.2 percent in the fourth, the median estimates of 61 economists surveyed by Bloomberg.

The signs of improvement haven’t translated into a turnaround in gas demand.

Consumption by factories and manufacturers will decline 9.8 percent this year, according to the Energy Department. Fuel production will increase 0.9%.

Even with this month’s rally, futures have dropped 71 percent from a 30-month high of $13.694 on July 2, 2008. The 29 percent decline this year makes gas the worst performer on the Reuters/Jefferies CRB Index of 19 commodities. The index has risen 9 percent, led by gains in copper, sugar and gasoline.

Natural gas will average $3.90 per million Btu in the third quarter, according a Bloomberg survey of 20 analysts, compared with $3.39 since July 1. Forecasts have retreated through the year. In March, the prediction for the third quarter was $6.

Outlook Revisions

The outlook for the fourth quarter, when demand for heating fuel typically increases, has also declined. Gas will average $5 in the next three months, according to the survey. The price expectation was $7.38 on Jan. 2 and $5.36 on Aug. 3.

With the U.S. economy recovering from the first global recession since World War II, some investors say gains will occur sooner. November futures will probably trade between $4.50 and $5.50 as demand strengthens, said Peter Linder, president of the DeltaOne Energy Fund in Calgary.

“We’re not going to see a collapse in gas prices over the next two months,” Linder said in a telephone interview. “We’re going to see significantly less production,” which will boost the fuel into 2010, he said.

Rising Prices

The December contract is likely to climb to around $6 from $5.66 now, Linder said.

“The entire move to the upside is predicated on recovery and stimulus, and if those two things hesitate or fail to materialize, so will higher prices for natural gas,” said Michael Rose, a director of trading at Angus Jackson Inc. in Fort Lauderdale, Florida.

Inventories rose to 3.525 trillion cubic feet in the week ended Sept. 18, 16 percent above the five-year average, and 91 percent of estimated peak capacity, according to Energy Department data. The previous record was reached in November 2007.

Supplies may hit maximum capacity of 3.899 trillion cubic feet before November, when utilities and power generators begin to withdraw the fuel for the heating season. The Energy Department will come out with the latest totals on Oct. 1.

The excess would be enough to meet almost a month’s worth of average daily consumption by households, factories and power plants across the nation during the cold-weather months, when demand peaks at an average of about 12 billion cubic feet a day, according to government data.

Storage Operators

Storage site operators take gas from producing wells through pipelines, usually from April through October. Using compressors, they force it down wells drilled into permeable stone, which are covered by a cap-rock to contain the fuel. A year ago, the caverns were 80 percent full.

The stockpiles have grown even after companies cut back on exploration. The number of rigs drilling dropped 56 percent to 710 as of Sept. 25 from a peak of 1,606 a year ago, according to Houston-based Baker Hughes Inc., the world’s third-largest oilfield-services provider.

Lower prices will keep a lid on rigs, said Cameron Horwitz, an analyst at SunTrust Robinson Humphrey Inc. in Houston.

The total fell to 665 on July 17, a seven-year low, after stockpiles rose to the highest for any week in July since 1994. The surplus helped send gas to the lowest level since March 2002 earlier this month.

Near Capacity

“Gulf South is reaching full capacity,” said Allison McLean, a spokeswoman for the company’s parent, Boardwalk Pipeline Partners LP, in a Sept. 22 interview. “We don’t have flexibility to go above and beyond what customers have contracted for.”

The company, with about 83 billion cubic feet of storage, said Sept. 4 that it may “subject offending customers to penalties.”

Southern Natural Gas, a unit of Houston-based El Paso Corp., owner of the largest U.S. network of natural gas pipelines, said on Sept. 21 that 96 percent of its available 60 billion cubic feet of space was in use as of Sept. 17. A year earlier, it was at 78 percent.

“The storage situation is a pretty serious one,” said Tom Orr, director of research at Weeden & Co., a brokerage in Greenwich, Connecticut. “There’s no real remedy in sight.”

Futures advanced this month after Fed Chairman Ben S. Bernanke said on Sept. 15 the recession may have ended already. A report on Sept. 1 from the Institute of Supply Management showed manufacturing expanded for the first time in 19 months.

Slowing Losses

Price gains accelerated as traders who had sold expecting declines bought the contracts back. The rally was helped by speculators who were betting against U.S. Natural Gas Fund LP, the world’s largest exchange-traded fund in the fuel, according to Adam Felesky, chief executive officer of BetaPro Management Inc. in Toronto.

When those bets failed, speculators canceled positions by buying October futures, sending the contract higher, said Felesky, whose company manages exchange-traded funds.

The gain in the October contract was the biggest over a three-week span since September of 2006, after hedge fund Amaranth Advisors LLC lost more than $6 billion in bad bets in the gas market.

Futures in 2006 initially dropped, reaching a four-year low on Sept. 27, partly because the fund was forced to unload its holdings. Prices then surged 62 percent by Oct. 18.

Production Cost

Gas may have to climb above $6 or even $7 to ensure producers pump enough to meet demand, Aubrey McClendon, chief executive officer of Chesapeake Energy Corp., said in a presentation to investors on Sept. 10.

Chesapeake, the fourth-largest producer in the U.S., has been selling assets to conserve cash and reduce debt during the drop in prices. Anadarko Petroleum Corp., the second-biggest, reported a second-quarter loss of $226 million

Weeden cut its 2010 forecast to $4.25 per million Btu from $5 in a report on Sept. 14, saying that stockpiles at the end of the heating season in March will be at a record high for that time of year.

“You have to start thinking what next April will look like,” said Orr of Weeden. “Coming out of winter and going into spring, you’ll still have a situation where the market will be oversupplied.”

To contact the reporter on this story: Reg Curren in Calgary at rcurren@bloomberg.net.

Last Updated: September 28, 2009 00:01 EDT

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