Earlier this month, I said that I wouldn't be surprised to see natural gas prices plunge below the $3 mark. I certainly didn't think it would take less than two weeks, but here we are.
With a substantial build in inventories reported by the government on Thursday, natural gas futures dropped more than 5% to the sub-$3 mark for the first time since 2002. So what happens now?
My view is that prices will go even lower from here. I just see nothing standing in the way of a massive storage build over the next few months.
Simple supply and demand
While average daily production peaked several months ago and should soon begin registering more significant declines, the volumes produced should still be enough to either fill the nation's storage capacity completely or at least come close. Many firms have certainly scaled back drilling activity, particularly the private "checkbook drillers." Domestic production already flatlined among the majors like BP (NYSE:BP), Chevron (NYSE:CVX), and ConocoPhillips (NYSE:COP).
That leaves the prodigious independents. The success of E&Ps like Chesapeake Energy (NYSE:CHK), Anadarko Petroleum (NYSE:APC), and XTO Energy (NYSE:XTO) -- and the reluctance by those firms to throttle down production growth to a significant degree -- will be the driver that takes gas storage levels to the brim.
The interesting thing is that the stocks of natural gas producers are not slumping along with the commodity price. Rather, they're trading higher as oil hits new highs for the year -- despite the fact that shops like Cabot Oil & Gas (NYSE:COG) are well over 90% gas-weighted.
What's next?
Is this disconnect a result of institutional ETF trades moving the entire sector? Maybe. But let's assume this is a display of the market's infinite wisdom, and ability to look past the storage build and to higher gas prices in 2010. If that's the case, why buy into the E&Ps at today's prices?
We can all talk about looking around the corner, but when the gas-on-gas competition starts this fall, will investors really keep their cool? I would personally prefer to see more pessimism before taking a position here.
