Friday, October 8, 2010

Natural Gas: Fundamentally Bearish but Expecting a Seasonal Rally

From guest analyst Papa Roach.....

Here we are, starting October on a good note weather-wise (at least in Houston). You couldn’t ask for a string of beautiful days like we have had. Last month’s price action indeed avoided the seasonal rally that has come to be expected like clockwork. The story has remained a bearish supply side, HBP drilling tale in shale (Hold By Production, a general lease clause).

The Atlantic tropical season is on its downhill slide, and we in fact did see a fairly active season with 14 named systems as of this writing, 7 of which were hurricanes and 5 of those majors. However, the offshore production area was unfazed this year with most activity staying away from the central gulf coast. The precautionary shut-in volumes were negligible. The big story of this summer has been extreme temperatures.

The summer of 2010 will go down in the record books as one of the hottest on record. The graph below depicts the meteorological summer (June-August) and compares quite bullishly to last summer.

The temperature regime created a spot market premium the entire summer that rivaled what you would expect to see in high winter heating demand as gas-fired power generation was humming along to meet the high CDD loads (Cooling Degree Day). These temperatures created a level of demand that masked the high level of US supplies and likely saved a few smaller E&P companies from very tough times.

However, the market’s ability to sustain prices that were high enough to keep a healthy drilling pace will likely be the unraveling for some as prices did not do their job of curtailing supply. Most drilling in shale is indeed for HBP purposes; however, there was still a moderate pace of traditional vertical wells that kept the supply side moving higher throughout the period.

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