Torrid storage injection pace deflating gas price expectations

May 18, 2001
Unless hot weather settles in soon, a blistering gas storage injection pace will begin to reverse expectations about exceptionally high gas prices this summer.

Unless hot weather settles in soon, a blistering gas storage injection pace will begin to reverse expectations about exceptionally high gas prices this summer.

In addition to the cool weather, some opportunistic marketers are jockeying to lock in highly attractive arbitrage spreads-exceeding 50¢/MMbtu before carrying and financing costs, according to UBS Warburg.

Together, these two trends are driving near-record rates of storage injection. Looking at American Gas Association data, operators injected 119 bcf of natural gas into storage for the week ended May 11. That's the third week in a row in which injection rates topped 100 bcf. It compares with 108 bcf the prior week, 46 bcf at this same time a year ago, 79 bcf the same week in 1999, and the record of 120 bcf set June 23, 1994. It's also the second largest injection rate since AGA began tracking these data in 1994.

Overall, the US gas storage level stands at 1.077 tcf. That compares with 1.366 tcf on average for the comparable week in the prior 3 years and 1.182 tcf on average for the comparable week in the preceding 6 years.

Consequently, the overall year-to-year storage decline-seemingly insurmountable just a couple of months ago-has shrunk dramatically, dropping for the past 6 weeks in a row. In the past 3 weeks, the deficit has fallen to 86 bcf from 159 bcf in the prior week and 209 bcf the week before that.

"Given the outlook for limited national cooling demand and the highly contangoed NYMEX strip, we expect that weekly injection rates will remain robust," UBS Warburg said. "As such, with the next 3 year-ago comparisons of 55, 56, and 78 bcf, we would not rule out a storage surplus by early to mid-June."

So it follows that, if injection rates from here on out average at least 70 bcf/week, storage levels could reach 2.8 tcf by the start of the heating season on Nov. 1. That's not far off the mark of 64 bcf/week for the span last year and the comparable period's rate of 69 bcf/week for the preceding 6 years.

All of this sudden surge in injection has deflated much of the expectation that this would be the year for a $5.00/MMbtu floor price. In fact, spot prices in recent weeks have flirted with penetrating the $4.00/MMbtu floor. Still, that's about $1 more than where prices were a year ago. And the slump is likely to brief, as prices are likely to rebound in the next month with the arrival of seasonal summer weather.

Much of this stepped-up injection rate also stems from the loss of demand owing to fuel-switching and decreased industrial sector consumption, both in response to high gas prices. Estimates have put this demand loss at anywhere from 5 bcfd to 10 bcfd.

However, don't if there is going to be a year-to-year storage surplus in June, don't expect it to be long-lasting. The kind of strength in gasoline prices that is helping to keep a prop under crude oil prices will transfer to the heating oil component in the fall, as refiners start scrambling to build heating oil stocks ahead of the heating season. There are other concerns likely to put upward pressure on crude oil prices as well, namely geopolitical ones. The US state department's proposal to amend the Iraqi sanctions regime, which will be reviewed in June, is certain to result in mischief by Saddam Hussein. Don't be surprised if Iraqi oil supplies are pulled from the market as a result, perhaps even for a protracted period. And Indonesia's government is nearing collapse, so that could be another critical component of supply taken off the world market. Plus, US gasoline prices will stay under pressure-despite a recent sharp drop in wholesale prices upon the strength of stockbuilding-because a refinery or pipeline outage in a system pressed to the limit is almost inevitable.

All of these factors will sustain pressure on the oil complex prices. Plus, hydropower supplies in the Pacific Northwest are perilously low for this time of year. So that means that natural gas will recapture much of the market share it's lost recently to fuel-switching, as gas prices become more attractive relative to those for fuel oil. In Europe, gas oil in the past week alone has jumped by $7.50/tonne.

In addition, a big chunk of new gas-fired electric power capacity is expected to come on stream this summer. All of these factors combined should exert enough pull on natural gas to slow down the storage injection juggernaut.

Meanwhile, gas drilling in the US and Canada continues apace. In the US, the gas rig count is beginning to approach the magic number: 1,000. It's still probably too early to tell if the stepped-up drilling action is having a material effect yet on the overall gas supply-demand balance-other than probably assuring a reasonable ceiling price over the next several years. If gas prices were to drift back down, say, below $3.00/MMbtu, and if oil prices nevertheless remained fairly high, then in a matter of months, operators would begin shifting their sights to oil, and the oil rig count would then begin to climb again at the expense of the gas rig tally-with the corresponding effects on supply and prices.

Remember the Golden Rule of Supply and Demand: the recognition of an impending shortage or surplus is the first step toward its reversal. Funny, isn't it, how oil and gas markets can work these things out on their own-absent intervention-regardless of how shrill the political rhetoric gets.

OGJ Hotline Market Pulse
Latest Prices as of May 18, 2001

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Nymex unleaded

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Nymex heating oil

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IPE Gas oil

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Nymex natural gas

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*Futures price, next month delivery. #Spot price

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