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Traders See Risky Storage Scenario, Yet July Drops

Despite an increasingly bullish storage situation, July natural gas continued lower Friday as traders see a return of more mild summer weather. At the close July had fallen 8.7 cents to $4.325, which is 43.2 cents lower than the previous week's close.

Analysts see a shortfall in storage that may be difficult to make up by the end of the injection season. "Through May we injected 759 Bcf last year, but for 2011 we have injected 571 Bcf," said a New York analyst. He noted that injections for 2009 were 12.3 Bcf/d and 12.6 Bcf/d for 2010. "Through May we are injecting 9.5 Bcf/d and the three year average is 11.6 Bcf/d."

"It's going to be awfully difficult to make up the difference to last year, and we are falling further and further behind. We are putting all our eggs in one [late-season injection] basket, but if we inject at the three-year average, we will be at an ending inventory of 3,630 Bcf. That would leave us 208 Bcf behind last year."

In his view, price momentum to the downside has largely run its course. "It's awfully difficult to think we are going much lower. What is interesting is that in Q1 2010 versus Q1 2011 BP, Conoco and Hess all reported declines in gas production greater than 10%, yet the Energy Information Administration reports production at 57.9 Bcf/d in Q1 2010 and 60.9 Bcf/d in Q1 2011. Who is making up the volumes? I understand that Bentek Energy has a huge balancing item in their matching of supply and demand," he said.

Market technicians looking long term see about equal strength to the bullish and bearish arguments. "In the bullish case this retreat from the pivotal $5.000 resistance is only the bull market correction of the rally from the $3.212 low," said Walter Zimmermann, vice president at United-ICAP. "That makes $3.890 the minimum target and $3.590 the must hold. In the bearish case on a decisive close below $3.590 the minimum implied target becomes $3.200-3.190."

Forecasters are calling for a return of mild heat this week. In its six- to 10-day forecast Commodity Weather Group predicts that above-normal temperatures (about 3 degrees) will encompass the East Coast from northern Florida to New York and New England. New Mexico and South Texas are also expected to be above normal. Below-normal temperatures are confined to the northern Plains.

"The upcoming heat events for the Midwest, East and South are expected to underperform significant heat from the first half of June," said Matt Rogers, president of the firm. "Due to various issues such as precipitation, a weaker hot ridge pattern and potential delays (especially Northeast), the overall forecast is same to cooler [Friday] for the upcoming two weeks in the Midwest and East. The cooler South [this] week associated with increased precipitation is still on track, but Houston is marginally above normal due to muggy low temperatures. Quick California heat should be same or slightly hotter than this previous event. The Tropics are quiet with no significant storm concerns over the next two weeks."

Just over a week ago July futures posted a high of $4.983, and within five trading days the market has managed to fall 57 cents or over 11%. "This shift from upward to downward momentum that began to develop about a week ago still appears to have about 15 cents left on the downside in our opinion," said Jim Ritterbusch of Ritterbusch and Associates.

Ritterbusch expects a falling rig count being able to provide some offset to increasing production. "We will continue to note that the market's ability to decline in spite of a growing supply deficit relates primarily to an ongoing up-trending pace of production that will likely continue through the summer and well into the fall period. But we will also note a gradual decline in gas-directed drilling activity that extends back some 10 months as a limiting factor to downside price possibilities. This is why we continue to have difficulty constructing a pricing scenario that would carry August futures much below the $4.30 area," he said in a Friday note to clients.

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