Dow Jones Market Week: U.S. Natural gas Price Cure.

Market Week - April 17, 2006

Commodities Corner: Lower Still?

There's an old saying among commodities traders that it takes high prices to cure high prices. If the corollary is that it takes low prices to cure low ones, U.S. natural gas prices may need to weaken substantially.

Despite falling nearly 60% from their December peak to a recent $7.135 per million British thermal units, nearby gas futures on Nymex may need to go below $5.50 to soak up a surplus unlike any ever seen by the industry. Total gas in underground storage on March 31, the official end of the heating season, was 1.695 trillion cubic feet, a whopping 63% above the average for the past five years and 13% more than the previous record high.

Much of the surplus is due to one of the mildest winters on record, and recent weekly data show only tepid signs of recovery in industrial demand in reaction to lower prices. Speculators betting on higher or even stable prices this summer may have to count on some extreme weather.

"You're going to need one of the hottest summers we ever had and a direct hit from a hurricane or you'll have bulging inventories," says Guy Gleichmann, president of futures broker United Strategic Investors Group. "The onus is on nature to deliver a dramatic blow."

While some meteorologists say that another hot and stormy summer appears likely, they aren't predicting a repeat of 2005, the warmest season in decades. Even an exact repeat of 2005 may not do the trick.

"We're looking right now at storage injections, adjusted for weather, about the same as last year," says Ron Denhardt, chief executive officer of Strategic Energy and Economic Research in Winchester, Mass. "The problem is, that can't happen."

Denhardt calculates that a replay of 2005 would leave gas storage at the start of the heating season at 3.6 trillion cubic feet, some 8% above the \ all-time high hit in 2004. That might exceed the physical limits of storage facilities.

But those fearing a true physical glut may be underestimating the U.S. gas market's remarkable flexibility. An episode four years ago, the last time storage hit an all-time high at the end of the heating season, is a case in point. Despite the surplus, prices rallied by over 25% during the injection season, when gas is injected into storage and a further 23% during the following heating season. Storage went from a record high in April 2002 to a record low in April 2003. Charlie Sanchez, a natural-gas analyst at Gelber & Associates in Houston, says 10 out of the last 15 springs have seen price increases, with an average gain of 54% from March 15 to May 15. Still, Sanchez isn't convinced history will repeat itself.

"'Tis the season, but this looks more like the exception years," he says. While prices have held their ground in the first two weeks of April, some analysts chalk this up to factors that may not have staying power, like sympathy with the resurgent oil market and aggressive storage buying by financially motivated, non-utility traders. Because of the futures market's steep upward slope, or contango, into next winter, non-utility owners of storage can buy gas today and sell winter futures to lock in a chunky profit. This artificial demand is temporary, warns Denhardt. Another source of support is coming from utilities reluctant to push their luck and wait for lower prices.

Once early storage buying dries up, prices may have to decline to create fresh demand. Analysts say that $5-$5.50 per million BTUs may do the trick, since some coal-fired electricity generators would switch to gas at that price, sharply boosting demand.

Then again, Sanchez cautions that being logical is often a losing proposition in gas trading and that just the fear of a tough summer could keep prices high and inventory bloated simultaneously. Says he:"The market's just schizophrenic."

By Spencer Jakab, 17 April 2006
Barron's (c) 2006 Dow Jones & Company, Inc.