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Analysts: Fat Caverns to Thin Producer Wallets

The lowest cash and prompt-month futures natural gas prices of the year are likely still to come as gas storage remains on track to reach record levels by the end of injection season despite a recent tapering of injections, analysts at Barclays Capital warned in a note last week.

Industrial demand for gas remains weak. "Anecdotal information suggests that while there may be pockets of improving industrial activity in recent weeks, it is against a backdrop of overall weak demand," the analysts wrote.

But the power generation sector is mitigating some of that, the analysts noted. While weather-based and seasonally adjusted power consumption are off 7.3% from peaks seen in late 2007, low gas prices are helping the cleaner fuel to edge out some coal demand among power generators.

Southern Company is an example of a generator that is relying much more heavily on gas-fired generation due to the current economics. During a conference call with financial analysts last Wednesday, CFO Paul Bowers confirmed for one analyst that gas-fired plants are being dispatched earlier in the company's generation stack.

"When you look at generation for us, quarter-over-quarter we're down in coal generation by 26%. Gas generation, we're up 93%. What that basically says to you is that we are dispatching our gas resources right behind our cheaper Powder River Basin [coal] resources," he said.

The greater reliance on gas-fired plants "has allowed gas to regain some lost ground," the Barclays analysts wrote. "We had anticipated that natural gas would displace coal-burning plants this year. Since total natural gas demand appears to be somewhat higher than our forecast, and industrial demand does not appear to be rebounding, we can infer that power sector consumption is higher than we anticipated."

Hence the lower storage injections of recent weeks, but demand is not the primary source of the shrinking injections, the analysts wrote.

"Falling supply, mainly from the U.S., is the principal driver of falling storage injections, we believe...Indeed, injections should continue dropping if U.S. supply continues to slide. We note that the supply drop-off to date has underpaced our estimates. Non-EIA [Energy Information Administration] data sources further suggest that the supply pullback has not been large thus far. Thus, if anything, U.S. supply is more resilient than our estimates, with a bearish consequence to storage and therefore prices."

Last week Baker Hughes Inc. said the number of rigs seeking natural gas rose by two to 677; however, the gas rig count is down 58% from its peak of 1,606 last September.

Last month the Barclays analysts said storage would reach 3,930 Bcf by the end of October (see NGI, July 27), and they reiterated that projection last Tuesday.

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