Weekly Natural Gas Notes: Natural Gas Storage Deficit To Five-Year Average Continues To Narrow

In the first quarter of fiscal 2014, Chesapeake Energy’s (NYSE:CHK) earnings benefited from the more than 30% increase in natural gas prices on the back of severe winter weather conditions in the Northern and Eastern parts of the country, which brought about higher heating related demand. This high growth rate came down in the second quarter as the price of natural gas dropped. Storage levels of natural gas had been falling since November 2013, and had dropped more than 50% below the average level for the last five years by the end of March 2014. This decline was caused by the high demand for natural gas from commercial and residential sectors.

However, storage levels have since started to increase, in turn bringing down the price of natural gas. The residential and commercial sectors together account for nearly 50% of the demand for natural gas in the U.S. During the first two months of 2014, demand from these sectors for natural gas grew by about 16% year-on-year, as the unusually cold winter season brought about need for more heating. ^[1] However, this only forms an isolated event that does not represent the underlying behavior of these sectors. Consequently, the demand from these sectors for natural gas is expected to decline in the coming months. Additionally, the U.S. Energy Information Administration (EIA) also forecasts the demand from the power sector, which accounts for 20% of the demand for natural gas in the U.S., to decline in the coming months. ^[2]

According to the United States Energy Information Administration (EIA), Natural Gas storage injections have continued to outpace the five-year (2009-2013) this April-October period. Inventories as of September 5 stood at 2,801 billion cubic feet (Bcf). ((Weekly Natural Gas Storage Report, EIA, September 2014)) During last year’s winter there was a huge draw down in inventory levels; stocks at the end of March were down by almost 1 trillion cubic feet and at their lowest level since 2003. According to the EIA’s short-term outlook, this trend is expected to continue this year, with forecasts pegging inventory levels at 3,477 Bcf at the end of October, or the lowest October-end level since 2008. However, the effect of the low inventories in the winter natural gas markets is likely to be mitigated by an expansion in production. The EIA cites the decreasing seasonality in natural gas futures contracts as evidence to support their forecast. ^[3]

Since natural gas accounts for more than half of Chesapeake’s total sales, the drop in prices could curtail Chesapeake Energy’s sales growth in the coming quarters. One factor that might offset the impact of declining natural gas prices on CHK’s profitability is that the company’s price realizations have grown faster than the broader market since the company benefited from some firm gas transportation contracts that it held on the Spectra pipeline in the North East. ((Chesapeake Energy Q1 2014 Earnings Conference Call, Seeking Alpha, May 2014)) The benchmark gas price on this pipeline, which carried some of  Chesapeake’s output from the North Marcellus, is based on the TETCO-M3 hub, which has been seeing a significant premium over NYMEX prices.

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1. U.S. consumers’ energy spending rose this winter, EIA, May 2014 [↩]
2. Natural Gas Consumption Report, EIA, June 2014 [↩]
3. Natural gas storage deficit to five-year average continues to narrow, EIA, September 2014 [↩]