Why Are Natural Gas Stocks Falling?

Trend: Natural gas production exceeds demand in the US at the current time, resulting in falling prices and storage facilities that are approaching capacity.

Gail the Actuary at The Oil Drum analyzes the natural gas production data for the US. Excerpts below.

The Pickens Plan looks like a viable energy strategy in light of the surplus of natural gas in the US.

Link: The Oil Drum | Can US Natural Gas Production Be Ramped Up?.

What happens when one increases natural gas production by 8% per day? There are a few places this can go--a little to offset a decline in imports from Canada, a little to use as exports to Canada and Mexico, and a little to meet the growing demand of electric utilities. Liquefied natural gas (LNG) imports can be reduced to their contractual minimum. On the industrial side, some factories with spare capacity can use some additional natural gas. It is difficult for these uses to absorb the 8% growth in production, however.

Once demand is satisfied, the remainder is added to natural gas underground storage. This past week, 102 billion cubic feet were added to storage; the week before 88 billion cubic feet were added to storage. The US is currently producing about 56 billion cubic feet of natural gas a day, so over the past two weeks we have put about 20% of production into storage.

Figure 8. Recent EIA Natural Gas Underground Storage Graphic

The problem is that natural gas underground storage is not terribly large, and it hasn't been increased recently in size to accommodate the new larger natural gas production. Historical data suggests that the practical limit of working storage is 3,600 billion cubic feet. This is a bit over two months' production. As of August 22, 2008, the amount of natural gas in working storage was 2,757 billion cubic feet, leaving only 843 (= 3,600 - 2,757) billion cubic feet of "space" available.

Once storage fills up, there is no other place for the natural gas to go. To make matters worse, it is very difficult for producers to shut production in, if there is no space available for storage, so producers will mostly continue to produce, whether or not there is space available.

Once traders realize that there is a significant chance that natural gas production will exceed storage space, prices start to drop. It seems to me that this is part of what has happened with natural gas prices recently. One consideration in deciding whether the supply will exceed the storage space is the long range weather forecast. The forecast is for a warm fall, meaning that little heat will be needed. We are also in the midst of an economic slowdown, and this is also likely to reduce natural gas use.

All of this makes for a bad situation for natural gas producers--lots of supply, but not enough demand, and prices dropping disproportionately to the prices of other fuels. In another post in the next few days, I will talk various approaches that have been proposed to increase demand, so as prevent this problem. I will also talk about the quantity of gas that might be available.

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The stock prices of natural gas producers have remained stable despite a 30% drop in the price of natural gas since the beginning of December.A combination of warm seasonal weather and record high inventories have sent gas prices to several-month lows but stock prices haven't followed suit...