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Natural Gas Market Report
NG in a tight trading range as markets thinks more production cuts may come
In the midst of an increased level of volatility in most risk asset markets Nat Gas futures have been trading in a relatively tight trading range since yesterday's very bearish weekly inventory report or about the most bearish inventory report since the winter heating season began. Seemingly orchestrated comments by Chesapeake officials about the possibility of cutting additional production (over and above what they have cut so far) seemed to be enough to serve notice to the short sellers that they may begin the process of supporting the price of Nat Gas. It certainly seems like a page out of the playbook of OPEC who for years tried to jawbone the market higher (mostly unsuccessfully) only to recognize that talk only does not do the trick it must be followed by significant cuts as we last saw when oil prices were collapsing back in the fourth quarter of 2008. So far talk of cuts has been mostly talk with actual announced cuts amounting to less than 1% of total production so far. That said it has been enough (so far) to prevent a major sell-off after yesterday's extremely bearish fundamental snapshot...but for how long!
The following table puts the announced cuts into perspective when compared to the current surplus in inventory versus both last year and the five year average as well as compared to my projected end of winter season (3/31/12) surplus in inventory. As shown in the table the announced cuts amount to about 1% of total production or about 0.67 BCF/day (I am assuming total production at 67 BCF/day) has been cut. Assuming the cuts actually started on Feb 1 and carrying the announced cuts through the end of the winter heating season (EOS) it will amount to a total cut in production of 60 BCF.
The table also shows my projected end of season surplus which is calculated by taking the current surplus and projecting the EOS surplus by assuming that the inventory withdrawals will underperform by 5% versus the five year average withdrawals between now and the end of March. My assumption is based on the mild winter continuing through March. This projection would result in a surplus of 667 BCF versus last year EOS and 758 BCF compared to the EOS for the five year average. Applying it to the announced cuts to date would lower the EOS inventory surplus to 607 BCF versus last year and 698 BCF versus the five year...far from a bullish outcome. In fact a very bearish outcome strongly suggesting that the market's current reaction to the announced cuts is way overblown.
I included a case that shows how much production would have to be cut from Feb 1st through March 31st for the EOS inventory level to be equal to last year and the five year average. As shown the cuts would have to be 11.1 BCF/day or 16.6% of total production to equate to last year and 12.5 BCF/day or 18.9% to end at the five year average. Obviously that is not a case that is going to happen but it certainly demonstrates the magnitude of what must be done for the industry to regain control of the price of Nat Gas as OPEC has done with the price of oil. It also further substantiates why I remain bearish Nat Gas for the foreseeable future... even as it appears prices are steady today.
On a positive note today's Baker Hughes rig count reported a 25 rig decline in rigs deployed to the Nat Gas sector...an over two year low while rigs deployed to the oil sector increased by 18 rigs. Rigs deployed to the Nat Gas sector remain well below the threshold (around 800) that many analyst would expect to see production starting to decline. We have not see that yet. Rigs deployed to the oil sector increased to 1263. Horizontal rigs decreased by 3 but still remain at near record high levels. The following chart kind of says it all when you plot Nat Gas rigs versus oil rigs and place the spot WTI/Nat Gas futures market price ratio on the chart. As long as the price trend continues E&P players are going to continue to be biased to oil drilling. In fact the oil to Nat Gas price ratio has widened to 39.8 or another all time record high level. At this level rigs are likely to continue to be moved out of the Nat Gas sector and placed in the oil sector.
The most interesting take away from this chart continues to be the fact that although we have seen a significant decline in rigs deployed to the Nat Gas sector production has actually risen during the same period (that could be changing now that some cuts in production have been announced (see above for more details). A lot of the oil drilling also winds up finding associated Nat Gas and along with the latest drilling and producing efficiencies even with less rigs production is still growing. Finally with oil/LPG prices still rising a major portion (if not all ) of the outright Nat Gas producing losses at sub $3/mmbtu gas is being offset and thus reducing the urgency for many producers to cut production even if they are not completely hedged. The decline in Nat Gas rigs still seems like it has room to decline... as recently as the fourth quarter of 2009 less than 700 rigs were deployed to the Nat Gas sector. If the producing economics of Nat Gas continue to decline or even stay at current levels as we approach 2013 we could see an acceleration in the decline of Nat Gas drilling as it appears that many producers are not sufficiently hedged for 2013 and beyond. On the other hand if oil prices continue at current price levels more and more rigs are going to be deployed to this sector.
Oil prices appear to be heading for a weekly gain with WTI up about $1/bbl on the week while Brent is higher by about $3/bbl with the Brent/WTI spread still trading about $2/bbl higher than where it was at the end of last week. The oil complex is mostly lower so far in early morning trading with the exception of gasoil in Europe which is being driven by the bitter cold weather engulfing a major portion of Europe. The macro indicators are in the price driver's seat so far today with the euro in negative territory and the US Dollar Index about 0.2% higher on the day...both bearish indicators for the oil complex. In addition equity markets in Europe are in negative territory while US equity futures are pointing to a lower opening on Wall Street also negative indicators for oil markets.
The negative macros are being driven by the fact that there is still no final Greek deal. The EU is holding firm insisting that there will be no financial aid until Greece clearly implements an austerity plan. The Greek Parliament is set to vote over the weekend on the latest austerity program. The market is moving back to a view that a Greek deal is not a slam dunk anymore as many were starting to believe last week and even until earlier this week. I still think there is a decent chance that a deal gets done...possibly sometime next week...assuming the Greek Parliament votes in favor of more austerity.
However, I can also see where a vote for more austerity in Greece is a difficult vote with the country in a mess and absolutely no growth coming from the economy for the foreseeable future. For example over half of the population of 15 to 24 year olds are unemployed. More austerity is not going to solve this growing problem nor is it going to result in economic growth anytime soon. So no a Greek deal is not a slam dunk and there is still a possibility that Greece does in fact default and is escorted out of the Euro zone. Stay tuned as this issue will continue to impact the global risk asset markets once gain as Europe is clearly back in the foreground.
All eyes still also remain focused on China insofar as whether or not the government will be able to orchestrate a soft landing and get the worlds main growth engine running on all cylinders once again. As I mentioned yesterday the latest increase in inflation may set back the government for a period of time in getting into a very aggressive monetary easing policy and thus postponing the time when the Chinese economy will see accelerated growth. Today China reported a decline in both exports and imports for January...the first decline in about two years. Much like the surprise inflation data it is not clear as to whether the data is the start of a new trend or simply an impact from the week long Lunar New Year celebrations. Domestic demand was weak in January while exports have been in gradual decline as a result of the slowing developed world economies...in particular Europe. With the disappointing January data so far it is almost certain that the Chinese government will drag their feet a bit before embarking on an aggressive easing policy...with special concern over the latest rising inflation data.
Geopolitics are still playing a role in the overall pricing of oil markets but for the last few days it has been playing a secondary role as all of the macro drivers have moved back into the forefront as discussed above. The sanctions are starting to hit Iran as some of the news media were reporting that Iran is actually entering into barter deals for the acquisition of some of its grains in trading oil for grains. In addition countries like India that are not abiding by the west's embargo are paying for oil with gold as the banking system is getting squeezed by the sanctions. So Iran appears to be getting a bit squeezed on the surface. Whether or not this will motivate Iran to enter into positive negotiations and ultimately end their apparent quest of nuclear weapons is a huge unknown. The evolving situation with Iran is still acting as a price floor as a minimum but each time the rhetoric or war of words increases this price driver moves more to the forefront.
I am still keeping my view at neutral and bias at bearish as once again there is not much supportive indications that Nat Gas is likely to embark on a major short covering rally anytime soon. The surplus is still building in inventory versus both last year and the five year average is going to get harder and harder to work off even it gets cold over a major portion of the US and as such for the medium to longer term I am still very skeptical as to whether NG will be able to muster a sustained upside rally over and above a short covering rally.
WTI is still trading above its intermediate support level even with the downside correction overnight. Brent has also breached its resistance level with a path that could possibly take it to the $118/bbl level. But as with WTI Brent is also in the midst of a modest downward correction pattern. I am keeping my view at cautiously bullish but raising the caution flag that the market is becoming more susceptible to a modest round of profit taking selling in the short term...which seems to be underway today.
Currently markets are mixed as shown in the following table.
Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com
Follow my intraday comments on Twitter @dacenergy
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