Road Map for Natural Gas
Under the Radar: A Road Map for Natural Gas Prices
By Christopher Edmonds
Special to RealMoney.com
06/13/2003 12:26 PM EDT
URL: thestreet.com
After the Energy Information Administration announced back-to-back record weekly growth in natural gas storage, the battle lines are being drawn.
Some pundits, including RealMoney columnist Mike Norman, think that natural gas prices have peaked. "Fade Greenspan," he quipped, referring to the Fed chairman's testimony that a natural gas shortage is something we have to live with.
Others, such as Marshall Adkins, director of energy research at Raymond James, think that high gas prices are the only way to crawl out of a supply and production shortage, with high prices reducing demand and creating new incentives for exploration companies to drill.
Whom should you believe? Unfortunately, there's no easy answer, and both could end up being right this summer, depending on a number of variables that will shape natural gas markets in the months ahead. Those may directly affect energy equities as the summer heats up.
Here's a quick look at a road map to help you gauge the future direction of natural gas prices.
1. Keep an eye on power generation statistics.
One reason for the two consecutive record storage builds is the lack of heating or cooling demand, reducing the need for natural gas to fuel power generation. One tell of natural gas storage is found in the weekly power generation statistics from the Edison Electric Institute. Released each Wednesday, these data detail the amount of power generated by region, and they have an uncanny knack for predicting the relative size of the natural gas build.
Although it's not always a perfect indicator of the storage build (because the generation fuel mix varies, including coal, oil, gas, nuclear, etc., each week), you can get a pretty good feel for the relative size of the build compared with last week's and last year's by tracking the EEI data.
More importantly, when strong demand for cooling occurs, you can expect a disproportionate amount of the electric generation to come from peaking plants -- electricity plants that run only during peak usage periods -- most of which are fueled by natural gas.
2. Watch the weather.
Summer temperatures play a very important role in determining natural gas demand. Watch the long-term forecasts from the National Weather Service and forecasting groups such as WSI. Natural gas traders keep a close eye on these forecasts, so when gas prices seem to be moving in the opposite direction from most other data points, check the forecasts. Last week, when the EIA announced a build of 114 Bcf in storage, gas prices actually rose, because longer-term forecasts suggested warmer-than-normal temperatures across key regions of the country.
Another weather issue to watch is the tropical wave map. This week, gas prices jumped because an early tropical depression was making its way across the Atlantic, and some forecasts put it on a course to potentially affect natural gas production in the Gulf of Mexico. The last thing natural gas pundits want to see is an early and strong hurricane season, which could affect already anemic production in the Gulf area.
3. Check second-quarter exploration-and-production statistics.
Although second-quarter earnings will be important for many energy companies, a more significant statistic will be the production growth reports from natural gas exploration-and-production companies. Just as we need more production, many E&P companies are just struggling to keep up. From a macro point of view, the production numbers will provide important clues to the direction of natural gas prices. Production needs to rise to ensure an abundance of reasonably priced gas for the 2003-2004 heating season.
On a company-specific basis, the E&P companies that can grow production at reasonable prices will, over time, post superior price performance. Those that fall short (witness Anadarko's (APC:NYSE - news - commentary) recent performance) are likely to be punished, regardless of how small the miss. If you want real evidence of how damaging a series of bad exploration misses and production shortfalls can be, take a look at the performance of a company like Spinnaker (SKE:NYSE - news - commentary) , an E&P company that has a love-hate relationship with the Street.
4. Watch nuclear plant capacity.
This may seem like a minor issue, but it could be a major one if summer heat soars. A number of nuclear plants are on the mend. FirstEnergy's (FE:NYSE - news - commentary) Davis Besse plant is likely to be out until at least late summer, a major South Texas nuclear plant is down, and one of Dominion's (D:NYSE - news - commentary) plants may face a lengthy outage.
These outages -- at plants that provide baseload electricity -- mean that more natural gas-fired generation will be required to meet basic demand. The threshold at which peaking plants run could be lowered, translating into even more demand for natural gas-fired generation. If additional nuclear plants face unexpected outages, demand will simply increas.
5. Identify signs of demand destruction.
As I've mentioned in Columnist Conversation, demand destruction can help moderate prices. We've seen a meaningful amount of fertilizer and ammonia production shut down as a result of high gas prices. If natural gas accelerates to higher levels, then demand evisceration is likely to escalate, and that would be a natural control on prices. It's hard to predict the exact relationship between prices and demand, because each industry is affected in different ways, but sustained prices above $7 per million cubic feet are likely to have a marked and potentially permanent impact on demand.
A number of other factors can impact supply, demand and therefore the price of natural gas. However, this checklist is a good start to help you frame the information that is likely to affect natural gas pricing as the dog days of summer approach. |
