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Will Supply Continue to Overpower Demand for Natural Gas in 2012?

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The most recent data is signaling a continuing bearish trend.

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While the S&P 500 (SPY) ended just about even on the year, gravity sure took its toll on Natural Gas (UNG).

Spot price natural gas at the Henry Hub pricing point in Erath, Louisiana, is down 32.4% since January 2011. The February contract for Henry Hub Natural Gas settled at $2.989 per million metric British thermal unit on Friday, slightly below the key $3 handle. Afterward, it drifted even a couple cents lower to $2.962/MMBTU. With gas now trending near lows last seen in 2009, there seems to be no end to its woes.

In the United States, approximately 25% of electricity is generated by natural gas power plants (see Why Increased Demand Will Save Natural Gas). Even during a year with record heat that strengthened electricity demand and left many power grids teetering on the verge of rolling blackouts, natural gas was unable to keep up the pace.

Demand load in the Electric Reliability Council of Texas (ERCOT) electricity market peaked at 68,379 megawatts on August 3. This figure blew through the previous record of 65,776 MW from August 2010 and settled over 7.8% greater than the next highest peak load quantity in June 2009. The Pennsylvania-Jersey-Maryland (or PJM) Interconnection and Midwest Independent System Operator (or MISO) regions also set records for demand load in summer 2011, on July 22 and July 21, respectively. Yet despite sky-high temperatures across the nation, spot price natural gas fell over 14.1% from June to August.

The sweltering summer heat served to prevent prices from a complete and total nosedive, but once November and December came around, a continuation of above-average temperatures reduced electricity demand. Such weather, in addition to the expectation of a mild winter, brought prices down to a level well below the forecasts of many experts.

The culprit? Without fail, supply continues to overpower demand. As of the latest inventory data released by the Energy Information Administration on December 28, inventory decreased by 81 billion cubic feet over the previous week, signaling a continuing bearish trend. Analysts had estimated a withdrawal in the range of 85 to 89 Bcf according to Platts, a provider of energy information.

For a better gauge of the significance of this draw, the five-year average of withdrawals during this week is 122 Bcf. The combination of below-average withdrawals as of late, as well as above-average injections over the summer and early fall, has contributed to an excess of natural gas in underground caverns. At current total storage levels, the 3,548 Bcf figure is 297 Bcf, or 9.14%, greater than the corresponding data point in 2010. In addition, it is 428 Bcf, or 13.72%, greater than the five-year average at 3,120 Bcf.

Barring any surprise freezes or unexpected increases in economic activity, an inflated storage level should continue in the short term. Still, with the arrival of a cold front along the Eastern seaboard this week that could push warm air away temporarily, perhaps there is potential for heightened natural gas demand. According to National Weather Service meteorologist Bill Simpson, until now, the mild weather is the result of a jet stream that has not shifted south on time. This unseasonal incident has trapped cold air in Canada and parts of the northern United States.

Will natural gas soon stop the bleeding and rise again? Or will we see a continuation of above-average supply? Only time will tell. Expect 2012 to most probably bring a clearer quantification of shale gas reserves and, more importantly, what fraction of this supply is retrievable at current prices.

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