Early Summer Update for Natural Gas and Electricity

My Energy Alerts primarily refer to Natural Gas, but my analysis also pertains to Electricity because of its high price correlation to Natural Gas. The purpose of this analysis is to discuss Natural Gas’ progress as it attempts to rebuild its critically low storage levels. By the end of the past winter heating season, at the end of March, inventories of Natural Gas were at 822 Bcf, which was 55% below the five-year average of 1,814 Bcf. The deficit of 992 Bcf (1,814 – 822) was a huge deficit at the start of the injection period beginning on April 1st.

Natural Gas supplies needed to increase nearly 5 Bcf per day more than last year to replenish supplies before the coming winter heating season. I have been warning this will inherently increase demand during the injection period, which runs from the beginning of April thru the end of October; thereby greatly increasing the risk for higher Natural Gas and Electricity rates in 2014 and beyond.

In my April 10th Video Alert, I stated we normally have approximately 3,800 Bcf  in storage when the winter heating season begins on Nov 1st. As of April 4th we had 826 Bcf in storage, which meant we needed to inject nearly 3,000 Bcf to replenish supplies by winter. To put this into perspective, we needed to average approximately 99 Bcf per week until the end of October. Last year we produced a record amount of natural gas and were blessed with a very mild summer and the average injection rate was 70 Bcf per week. This year we need to inject Natural Gas into storage at a rate never experienced before to bring storage levels back to normal by this year’s winter heating season.

In my May 8^th Energy Alert, I said the mountain we needed to climb was getting steeper. We had a disappointing start in the first 5 weeks of the injection period, and the injection rate needed to increase even more than my previous estimate of 99 Bcf. After the May 8^th EIA weekly report we now needed an average injection rate of approximately 105 Bcf to rebuild inventory levels by the end of October, which meant injections had to increase by 50% over last year’s injection rate of 70 Bcf. In my May 8^th report, I also said Injections should increase over the next 4 to 6 weeks prior to the summer cooling season taking effect, and it is possible the market may experience a shallow pullback. But I stated it was important to understand any pullback over the next 4 to 6 weeks would be shallow and the risk/reward of delaying securing fixed rates may not be in your best interest.

As anticipated Natural Gas injections increased over the last 6 weeks with triple digit increases ranging from 105 to 119 Bcf per week. But these increases were a direct result of lower demand prior to the summer cooling season and we still have a large mountain to climb to bring storage levels back to normal. Inventory levels now stand at 1,719 Bcf, and with 20 weeks remaining in this year’s injection period we still need an average injection rate of 104 Bcf to reach our goal of 3,800 Bcf prior to the winter heating season beginning on Nov 1^st.

But the demand for Natural Gas is about to increase dramatically as the summer cooling season takes hold. In my early winter Energy Alert on January 3^rd, I said we were 9% below normal entering the winter heating season, which meant from a fundamental perspective the risk of higher prices this past winter were a very real possibility. Anyone who delayed hedging their Natural Gas and Electricity exposure in early January learned from bitter experience the importance hedging when there are fundamental risks for higher prices.

We are now entering the summer cooling season 33% below normal levels and obviously the fundamental risks of higher prices is greater now than early in January. In my May 8^th report, I said if demand for Natural Gas increased due to a warmer than normal summer, or a major storm disrupted production of Natural Gas we could see a rally in Natural Gas AND Electricity to levels above what we experienced last winter. No one knows precisely when the energy markets will again spike upward, but obviously the upside risk near-term is substantial.

The large injections of Natural Gas over the last 6 weeks have kept Natural Gas in a trading range from $4.40 to $4.80 MMbtu. We are presently trading near the lower end of the range, and a close below $4.40 could trigger a quick decline towards $4.00 in an attempt to fill a gap left behind when the market began its surge higher last winter. The chart below shows this possible objective.

Reaching this possible price objective would be the perfect scenario for entering new hedges, but I do not advocate hedgers trying to catch the exact bottom. I leave that for speculators. If they miss the bottom it does not cost them anything except opportunity cost, and opportunity cost is not as expensive as lost capital. But hedgers do not have that luxury, since if they miss the bottom and are not hedged they are inherently short the market. As discussed in my last Energy Alert on May 29^th, the risk/reward ratio was approximately 3 to 1 against delaying reserving your next hedge. Based on the latest inventory levels and today’s price levels, I believe the risk/reward ratio is now greater than 3 to 1.

Not every client’s risk tolerance and hedging strategy is the same, but we trust the above report will help you put into perspective the risk/reward opportunities at this time. I invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Senior Energy Analyst