Why inventories reflect oil and natural gas supply and demand

Why did last week’s natural gas report drive prices up?

Natural gas inventories increased more than expected

On Thursday, May 22, 2014, the EIA reported that natural gas inventories increased by 106 bcf (billions of cubic feet) for the week ended May 16, bringing current inventories to 1,266 bcf. A survey of experts had estimated the rise in inventories to be 103 bcf.

2014.05.28 - NG vs CHK vs KWKEnlarge Graph

Natural gas storage facilities require some base gas supply to remain on a permanent basis in order to ensure adequate pressure and deliverability during the winter natural gas withdrawal season. “Working gas” refers to the gas in storage above base gas levels.

Last week’s build in natural gas inventories was greater than the market’s expectation, which indicated stronger demand or weaker supply than expected. Investors can interpret this as a negative signal for natural gas prices. Natural gas prices traded lower on the day to close at $4.36 per MMBtu—compared to $4.47 per MMBtu the previous day.

Natural gas price volatility is important for gas-weighted energy producers like CHK

Investors who are long natural gas through an ETF such as the U.S. Natural Gas Fund (UNG) or natural gas producers such as Chesapeake Energy (CHK), Devon Energy (DVN), Range Resources (RRC), and Quicksilver Resources (KWK) should monitor inventory draws and builds because they’re significant data points in the national supply and demand picture of natural gas. The supply and demand dynamics of the commodity affect its price and, in turn, the margins of companies that produce natural gas. This week’s slight increase in natural gas prices could then be positive news for these companies.

Background: Natural gas inventories are far lower than average

Current natural gas inventories are roughly 45% lower than the average of the past five years, as last winter brought extremely cold weather. Natural gas demand surged, which resulted in large depletions of inventories as well as a rise in prices. The front month natural gas futures contract was trading around ~$3.50 per MMBtu in early November to peak above $6.00 per MMBtu at points in February and is currently at ~$4.50 per MMBtu.

The markets will be watching to see how natural gas inventories move through the spring and summer ahead of the peak winter demand season. Inventory levels that remain below average could prime natural gas prices for a rally this coming winter.

To learn more about investing in oil and gas, see the Market Realist series Must-know: Why US oil and natural gas rig counts both rose.