Despite Punxsutawney Phil’s prediction on Groundhog Day of a longer winter, the near-term outlook for natural gas is “very bearish,” and the second half of winter and the rest of 2008 “will be ugly for gas prices,” Raymond James & Associates Inc. said last week.
In their Stat of the Week, analysts J. Marshall Adkins and Collin Gerry said that even with the “bandwagon” excitement about U.S. gas prices, “difficult weather comps over the next six weeks, surging U.S. gas production and an increase in summer liquefied natural gas (LNG) imports should drive U.S. gas prices meaningfully lower over the next six months.” Gas-weighted stocks will “unfortunately” track closely with the gas price.
“Right now, our best guess is that these stocks likely bottom in September/October before rallying to end the year,” wrote the duo. “Thus, while the ‘gassy’ stocks have outperformed on a relative basis as gas moved from $6/Mcf to $8/Mcf in early winter, we expect this trend to reverse for the balance of the winter and into the summer.”
Last September the Raymond James duo wrote that gas prices and related stocks were setting up for a short-term bullish move, a call that was “largely based on easy year/year (y/y) weather comps from the first half of last winter and the perceived bullish gas draws that would likely occur through January.” However, since then front-month gas prices have rallied from the $6/Mcf area to the mid $8 area. “The key driver of this bullish move has been the y/y gas storage differential moving from a bearish surplus of 56 Bcf to a bullish deficit of over 300 Bcf. As expected, ‘gassy’ energy stocks have outperformed the ‘oily’ stocks during this gas price move.”
Adkins and Gerry noted that several analysts “are now beginning to jump on the gas stock bandwagon. We are not.”
The reason they believe U.S. gas prices have peaked is because the y/y gas storage differential “is poised to sharply reverse to the bearish side over the next month. Specifically, we think that normal weather will drive the y/y gas storage differential from the current bullish 300 Bcf deficit to a bearish 100 Bcf surplus over the next 60 days. If we have said it once, we have said it a hundred times: the y/y storage differential is the key short-term trading driver for near-term gas prices…Unfortunately for the gas bulls, we expect the y/y gas storage differential to turn very bearish over the next two months.”
According to Raymond James, U.S. core gas supply came in higher than analysts expected for several reasons. The energy team modeled a 1.5 Bcf/d increase in U.S. supply, but “it now appears we were up closer to 2.4 Bcf/d.” Also, Canadian imports have not declined as much as they assumed. The U.S. Energy Information Administration is reporting that Canadian imports “were actually trending up over 1 Bcf/d on a y/y basis,” and “we believe the actual Canadian exports were down closer to 0.6 Bcf/d (more bearish than initially forecast). While these two miscalculations would have left a more bearish picture, we were also off on our LNG assumptions. We thought LNG imports would be up modestly when they were actually down nearly 1 Bcf/d (more bullish).
“Oddly enough, the sum of these three nonweather-related forecast errors nearly cancel each other out, leaving weather, and its cumulative effects, as the largest delta versus our original model.”
The sum of nonweather-related gas supply/demand variables was mostly in line with the Raymond James’ model, “yet we drew 108 Bcf more out of storage than we had forecasted. What gives? Our best explanation is that we underestimated the amount of gas demand associated with meaningfully colder weather this year relative to last year. Simply put, colder weather drives exponentially more demand.”
Assuming 10-year normal weather, the analysts are forecasting a warmer second half of winter compared with a year ago.
“Despite the last two weeks being colder than normal, the weather tide is set to change over the next few weeks,” they wrote. “We are now assuming that the momentum for increasing core U.S. gas supply continues, driving an incremental 2.6 Bcf/d more ‘core’ gas supply than last year. Likewise, we are assuming that the two predominant foreign trade factors, LNG and Canadian imports, maintain their most recent y/y trends. However, when we adjust for warmer anticipated y/y weather, it now appears we will have nearly 4 Bcf/d less gas demand over the next 70 days than we had last year. In other words, the bullish weather comparisons we have seen so far this winter are poised to turn very bearish over the next two months. All in, we are forecasting a 359 Bcf bearish swing in the y/y gas storage differentials. For the full winter, this should leave ending storage at 1,664 Bcf, which is over 100 Bcf more gas than last year.”
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