Conclusion: Natty poking up its head for a trade, but fundamental headwinds remain.
Our U.S. Sector Strategist Howard Penney, who tweets under the handle hedgeye, highlighted the recent outperformance of natural gas versus other commodities over the last couple of weeks. In the table below, which highlights that over the last week, natural gas is the best performer of the four headline commodities – oil, copper, gold, and natural gas. Natural gas is up 7.3% versus oil down 5.4% over the same period. Over the longer term, three years in this analysis, natural gas is still a dramatic underperformer, and is down almost 44.4% in that period.
The recent underperformance of oil and copper has clearly been driven by increased tightening measures, or the prospects thereof, in China. Since natural gas is a more localized commodity, and we track its U.S. based price, it is not impacted by China, or global demand. The price of natural gas is driven by both supply and demand in the United States, while copper and oil are driven by global supply and demand, with Chinese demand being the incremental marginal demand for both copper and oil.
Clearly one of the primary factors driving the short term price is the April 20th explosion on rig Deepwater Horizon, which is currently leaking an estimated 5,000 barrels per day. In the intermediate term, this will curtail, on the margin, production and exploration in the Gulf of Mexico, which is negative for natural gas supply. In aggregate, the Gulf of Mexico is responsible for 12% of U.S. Natural Gas production, so any curtailment of production in the Gulf is meaningful. This will be a key area of focus for us over the coming months, as there is potential for some major issues as it relates to natural gas production and exploration.
In aggregate though, supply in the United States is still at a very high livel versus the last five years, and versus last year. According to the most recent data from the EIA, current storage in the domestic U.S. is 2,089 billion cubic feet, which is ~4.5% above last year and 18.4% above the trailing five year average. Despite this short term pop in price and potential disruption issues in the Gulf of Mexio, this high level of supply is going into a period of seasonal supply build, and should contain the upward increase in natural gas price.
From a quantitative perspective, though, we do see more upside in the short term for Natty. We’ve outlined the levels in the chart below, but see upside to the level of $4.59 on the NYMEX. To get bullish beyond this, we would need to see supply start to moderate in the U.S. at least directionally.
Additionally, despite this high inventory build, natural gas drilling has been growing on a year-over-year and sequential basis since the first week in March. In fact, as of last week natural gas drilling was up +31% year-over-year. This, obviously, doesn’t bode well for supply coming down and a sustained increase in price.
Play Natty for a trade up to its Sell line, but leave a trade a trade.
Daryl G. Jones