Commodities

Increased Demand Fails To Spark Natural Gas ETFs

Despite a heat wave that has hit the country this summer, pushing up demand for electricity and hence natural gas, the commodity has been unable to see positive price support which is illustrated in the performance of the US Natural Gas Fund (UNG), the First-Trust ISE-Revere Natural Gas (FCG) and the iPath DJ-UBS Natural Gas TR Sub-Idx ETN (GAZ).

In the past, the price of natural gas has moved in tandem with changes in the amount of gas injected into underground storage.  Furthermore, the amount of storage is closely correlated to shifts in weather patterns and as temperatures rise, the amount of power used to cool homes and businesses rise (natural gas is used to power electricity plants which supply power), hence amounts of gas injected into storage decrease.  The end result is an imbalance in supply and demand resulting in increased natural gas and electricity prices.

According to data from the Energy Information Agency (EIA), this phenomenon is prevailing; however, prices in the commodity are just not rising.  Storage surplus has been eroded by summer heat, which has led to below-average injections into storage. In fact, stockpiles of natural gas now stand at about 7% above the five-year average, as compared to 18% above the five-year average in May of this year.  As for prices, they have been unable to break the $5 a million British thermal units (MMBtu) mark and the EIA estimates that the average price of natural gas will be $4.69/MMBtu this year.

One of the major reasons that this price trend in natural gas is deviating from the norm is the continuing production of natural gas in shale regions which ensures robust future supplies and mitigates the risk of having a supply and demand imbalance.  In fact, the number of rigs that are drilling for natural gas has increased by 42% from a year ago and has pushed stockpiles of the commodity to levels seen in the early 1970’s. 

To further support the notion that future supply of natural gas is likely to remain plentiful, exploration and production companies will continue to drill.  Despite prices that are below the cost of production in some of the most prolific U.S. gas fields, drillers need to continue to drill into shale formations in order to prevent a forfeiture of their leases.  Additionally, if a driller successfully drills a gas well, it can hold the lease in perpetuity, maintaining the right to drill future wells in hopes that other forces will result in supply and demand shocks which will provide price support of the commodity. 

In a nutshell, natural gas drillers will continue to drill in shale formations to ensure they don’t lose their lease rights, which is likely to keep supply and demand of the commodity in-line and the price of the of the clean burning fuel relatively low.

Disclosure: No Positions

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