Heat wave heats up natural gas prices to record high

Summer's dog days are here, and this week that canine seems likes a pit bull on crack.

It's hard to tell what's hotter right now: the weather in the US Southwest and South Central states, the country's natural gas drilling rig activity, or natural gas futures prices. All three categories are marking record highs this week.

The recent heat wave is only aggravating an already tight supply situation. The surge in cooling load demand as temperatures routinely topped 100° F. across much of the aptly named Sun Belt has weakened natural gas storage injections at a time when the pace of storage refill needs to remain robust if the Nov. 1 heating season onset target of 3 tcf is to be met.

Storage lags

Looking at American Gas Association data, industry injected 52 bcf of gas into storage last week, down from 55 bcf the previous week and 69 and 57 bcf in the comparable weeks of 1999 and 1998, respectively. That leaves the year-to-year storage deficit this week at 377 bcf, compared with 360 bcf last week and 365 bcf the week before that. At this point, the storage deficit should be shrinking, not climbing. Given this rate of injection and the expected continuance of hot weather through the upcoming Labor Day holiday, the market can count on the storage deficit to remain pretty much where it is now for another week. That can be seen in a comparison with historic trends that suggest the next week's injection rate needs to reach 66 bcf to keep from losing still more ground.

The hot weather was abetted by pipeline disruptions in the West, most notably the shutdown of a key El Paso pipeline as a result of the tragic explosion in New Mexico that claimed the lives of 11 campers.

In addition to forecasts calling for warmer than normal temperatures in the western third of the US this week and expectations for sizeable volumes of nuclear power capacity going off line, there isn't much in the way of incentives for operators to inject gas now. Looking at the historic-trend comparisons, injection rates should be escalating sharply the next 3 weeks-81, 78, and 79 bcf, according to PaineWebber estimates-in order get the pace of injection back on track. Given the very slight likelihood of that happening, one can expect the year-to-year storage deficit to grow this month, not shrink.

For industry to reach the magic 3-tcf number by Nov. 1, it would have to inject gas at a rate of 89 bcf/week from this point out. Compare that with the refill rates of 50 bcf/week for the same period last year and 59 bcf/week for the preceding 5-year average for the period.

Given this situation, PaineWebber estimates that storage will come in at 2.7 tcf or less on Nov. 1, with the latter a growing likelihood.

Record prices

The sizzling temperatures translated into sizzling action on spot markets, as the composite spot price of natural gas in the US rocketed a quarter to a record high of $4.40/MMbtu for the week ended Aug. 25.

Compare that with a pretty hefty $2.86/MMbtu that raised eyebrows at the same time a year ago. Natural gas futures even flirted with the seemingly unthinkable $5/MMbtu on the New York Mercantile Exchange yesterday. While a return of nuclear capacity and cooler weather in the late summer will ease the upward price pressure somewhat, the 12-month NYMEX strip is now trading at $4.33/MMbtu, a whopping $1.66 more than a year ago.

Drilling count record

Needless to say, all this market heat is also firing up the drilling rig markets. The total US rig count is about the pierce the key watershed of 1,000. The Baker Hughes count averaged 996 last week, vs. 668 the same time a year ago.

For the year to date, the Baker Hughes US tally has averaged 845, vs. 556 in 1999 and 890 in 1998.

Looking at monthly numbers, the count of US drilling rigs directed toward natural gas shot to a record high of 779 in August, besting the previous record, set in July, by 46 rigs.

Similarly, the Canadian rig count is running more than 50% above year-ago levels, averaging 369 units for the year to date.

So, will all this frenzied gas drilling action take the wind of the gas market's sails? Not likely, because it's coming too late to make that much of a difference in terms of supply this winter. And we haven't begun to factor in the possibility of further supply disruptions owing to the onset of the hurricane season in the Gulf of Mexico.

There even remains a question as to whether all this drilling is making a significant difference in production right now. Lehman Bros. Notes that US gas production is down about 2% for the year to date, compared with last year, while gas drilling activity is up by 51% in a year-to-year comparison. The gas production decline is likely to ease up in the second half, so Lehman thinks that US gas production growth will continue to lag demand in 2001.

Combined with the growing likelihood of a return to normal (i.e., cold) winter weather this year, after dodging the bullet for three consecutive El Nino/La Nina years, the new floor for natural gas prices for the foreseeable future may well prove to be $4.

But it's harder to speculate on the gas price ceiling this winter. Given the almost certainty that heating oil supplies will remain tight, gas supply outages and another Siberian Express could mean almost unthinkable spot prices: $6? $7? $10?

Looking at the Houston skyline today, just as there is little cloud cover to offer relief from 108°, there seem to be few clouds on the horizon for natural gas markets.