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Analyst: Storage Surplus, Natural Gas Prices Resume Inverse Relationship

As the summer heat drags on and the natural gas storage surplus over last year continues to decline, natural gas prices are on the rise. After taking 2004 off, this inverse relationship between storage and gas price appears to be healthy once again, according to Stephen Smith of Stephen Smith Energy Associates.

In his latest Weekly Gas Outlook, Smith said the storage surplus is likely to take another hit this week when the Energy Information Administration releases its storage report for the week ended Aug. 5.

"Our weekly gas supply/demand model projects a storage build of 61 Bcf for the week ending Aug. 5. Storage is projected to increase from 2,420 Bcf to 2,481 Bcf," said Smith. "This projected build compares with a normal seasonal build of 70 Bcf (based on 1994-2003 norms)."

He added that this 61 Bcf build vs. a normal 70 Bcf build implies that 'seasonal storage vs. normal' will decrease by 9 Bcf, from 261 Bcf to 252 Bcf.

Cooling degree days (CDD) for the week ended Aug. 5 were 10 CDD (14%) above normal (82 vs. 72), Smith said. "This was the fourth hottest week of the summer, but it was hotter than any week last summer." He added that the Aug. 12 week is now expected to be 11%-12% hotter than normal (one week ago Aug. 12 was expected to be only 6% over normal). "Early forecasts have tended to get hotter this summer."

For years, Smith has been studying the correlation between natural gas storage levels and Henry Hub natural gas prices. "Until the last year, a strong negative correlation existed between the '1994-2003 based deficit/surplus' and weekly average Henry Hub gas prices," he said. He added that the cumulative affect of hurricane Dennis -- plus hot weather over the last few weeks -- has produced a sharp multi-week decline in the gas storage surplus.

Smith noted that in the nine weeks between June 3 and Aug. 5, CDD have been a cumulative 96 CDD (17%) over normal. During that time, the gas storage surplus has been reduced from 420 Bcf to 252 Bcf, a reduction of 168 Bcf. "If we assume that 18 Bcf of the 168 Bcf total decline is due to Dennis (net of incremental Canadian imports which partially offset Dennis), then 150 Bcf is attributable to the 96 CDD over normal," he said. "This works out to be 1.56 Bcf of surplus reduction per CDD over normal." He noted that this ratio last week was estimated to be 1.48 Bcf, so it does vary from week to week.

Over that same nine week period, there was a strong upward move in natural gas prices. After taking 2004 off, Smith said the traditional inverse relationship between gas prices and storage surplus has reappeared.

Natural gas prompt month futures ended the weeks Friday June 3 and Friday Aug. 5 at $6.88 and $8.70, respectively, a $1.82 increase over that nine week period. For more information go to www.stephensmithenergy.com/ .

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