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Traders Mull Bearish Inventory Report, Oil Prices; July Sinks

July natural gas underwent a double-digit drubbing Thursday following a government inventory report showing greater-than-expected additions to inventories. Traders were surprised by the 98 Bcf addition reported by the Energy Information Administration, and prices promptly fell as expectations were for a smaller build. At the close July was 12.4 cents lower at $4.193 and August had dropped 13.3 cents to $4.217. July crude oil cascaded lower, giving up $4.39 to $91.02/bbl.

Analysts contended that although natural gas inventories are behind both one-year and five-year averages, no real pattern had emerged showing a consistent over- or underestimation.

"I don't think we have had a pattern yet of the inventory numbers being consistently larger or smaller than market expectations," said a Chicago banker. "When you look at a four-week average, I think the injections are coming out where expected. We traded down to the 200-day moving average at $4.18, and if that breaks, we could have another round of selling come in, but I am sticking with my range for the summer of $4 to $5 give or take a dime or so. If we get down to $3.85, I am still declaring a win as long as we don't go to $3.50. [A] $1 range in the natural gas market by historical standards is quite narrow."

Observers were bracing themselves for a large number. "It's gonna be a big one this week, folks, but not big enough to make much of a dent in the year-on-year or the five-year deficit," said John Sodergreen, publisher of Energy Metro Desk Express, before the storage report.

Expectations across a broad spectrum of traders were consistently low of the mark. For the week ended June 17 a poll by Reuters revealed an 88 Bcf sample mean of 26 analysts with a range of 76 Bcf to 90 Bcf, and Tim Evans at Citi Futures Perspective anticipated an 82 Bcf build. Ritterbusch and Associates was looking for an 84 Bcf increase. Bentek Energy, utilizing its North American flow model, calculated an increase of 91 Bcf. The actual figure of 98 Bcf was well above last year's 81 Bcf build and a five-year average 86 Bcf increase. Following the report inventories now stand at 258 Bcf lower than last year and 64 Bcf shy of the five-year average.

The banker made reference to the falling oil markets, and when queried whether his estimate of crude oil at $85 would impact natural gas he said, "I'm always looking at that from a substitution standpoint, but I think you have to ask: 'do high oil prices actually push gas prices lower because of the liquids extraction that can come from natural gas?' If oil prices remain high, there is an incentive to drill for more to extract the liquids even if the methane isn't worth very much. However, if oil prices fall, there may be less of an incentive to drill for natural gas [and produce the liquids] and natural gas prices rise.

"I think the [natural gas] market will trade more like that than it will based on any historical relationship where oil has to be seven and a half times what gas prices are. I don't buy that for a minute." He said he believes high oil prices push gas prices down and low oil prices eventually raise gas prices.

Complementing any impact of lower oil prices is the school of thought that the storage deficit is likely to build in coming weeks, possibly leading to a triple-digit differential to the historical averages. Evans' model shows expected builds of 76 Bcf, 76 Bcf and 71 Bcf for the weeks ending June 24, July 1 and July 8, respectively, below the five-year average builds of 77 Bcf, 80 Bcf and 80 Bcf for the same weeks. "With the storage flows as forecast, the year-on-five-year storage deficit would widen from the 76 Bcf level as of June 10 to a 101 Bcf shortfall as of July 8. A widening deficit typically puts upward pressure on prices over the immediate term, but we also see the natural gas market as already saturated with speculative long positions," Evans said in a report to clients.

Bears were treated to a three-peat where prices have now plunged following three consecutive inventory reports. Thursday's decline follows the report for the week ended June 10, which showed a build of 69 Bcf, well below historical averages, and July futures dropped 16.5 cents to $4.412. The figures for the week ended June 3 showed an increase of 80 Bcf and were also below the long-term averages, but July futures obliged by falling 17.3 cents to $4.674.

Weather forecasts dovetail with near-term subpar builds. WSI Corp. of Andover, MA, said in its six- to 10-day forecast. "With the exception of the Northeast and Florida, above-normal temperatures are forecast over most of the central and eastern U.S. Anomalies as warm as eight degrees above normal are anticipated over the Midwest and portions of the central and southern Plains."

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