There is an increasing risk that natural gas prices will fall to $4 or less by February because of excess gas supply on the market, and if that happens investors should be prepared for a potential 20-30% drop in E&P share prices, said Lehman Brothers analyst Thomas Driscoll last week in a research note.

“Over the past several months, natural gas storage behavior has implied that supply and demand are out of balance,” Driscoll noted. “Excess supply in the market appears to be growing, having reached nearly 400 Bcf of storage overhang, which has been encouraged by weak winter weather and storage withdrawal rates about 2 Bcf/d less than historic data…”

The year-on-year storage surplus has grown 150 Bcf in just the last six weeks, Driscoll said. “We appear to be on track to exit winter with about 1.65 Tcf of gas in storage if the remaining 16 weeks average about the same as the five-year average winter weather and 1.35 Tcf if we have normal winter weather for the remaining weeks.” That would compared to about 1.1 Tcf of gas in storage at the end of the heating season over the last five years.

As a result, there is about a 30% risk that gas prices could plummet back to 2002 levels below $4 by mid-February, Driscoll said. “The risk is that natural gas prices would need to fall toward the $3.25/MMBtu average price experienced in 2002 when storage was around 1.5 Tcf at season’s end.”

Gas prices will need to fall to recapture demand, but Driscoll noted that bearish predictions last year turned out to be inaccurate because oil prices were strong, providing more support than expected for natural gas.

“This has led us to remain hesitant to make an overly bearish call a second year in a row based on data that turned out to be misleading last year — yet bearish data has persisted for an additional 4-6 weeks this year around,” he said.

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