Natural Gas Inventories and Possible El Niño Winter Analysis
By Chris Puplava, October 4, 2006
On September 19th AccuWeather released its Preliminary Winter Outlook. Their chief long-range forecaster is predicting a much different coming winter than what we experienced last year. They are calling for an El Niño that will lead to a mild start and then a colder ending than normal.
"While temperatures in the Northeast will start out warmer than normal, a shift to colder weather during the final two months of winter will result in slightly below normal temperatures for the three-month period. This will lead to consumers needing more heating oil or natural gas than they did during last year's exceptionally mild winter," said AccuWeather.com Director of Forecast Operations Ken Reeves. "Chicago, which is dependent on natural gas heat, experienced relatively warm winters the past few years, and we expect this pattern to change this year. The last time we had an El Niño--the winter of 2002-2003--Chicago had to contend with slightly colder-than-average temperatures."
Winter weather for the East Coast will show more precipitation and colder temperatures while El Niño winters lead to a large high-pressure system that develops over the Rockies, which keeps conditions relatively dryer and warmer than normal.
After reading the preliminary forecast for this winter I wanted to look at current natural gas inventories and compare them to historical ranges and analyze what occurred during the previous El Niño of the 2002-2003 winter and its affect on natural gas inventories and the commodity price.
I reviewed natural gas inventories from 2002-2006 to determine various patterns and averaged inventories for each month since 2002. I then plotted the average inventory level for each month along with two standard deviations above and below the average. Approximately 95% of the average inventory levels should fall within the range of two standard deviations from the average. Values outside this range represent extreme values and are statistically significant.
As shown below, peak inventories are reached in November with the trough in the winter draw down occurring in April. A few key points I want to point out. There is not much variability between the maximum and minimum inventory levels from September to December. Greater ranges between the maximum and minimum inventory levels are seen from January to May, which is the peak of the winter season. The divergences in maximum and minimum inventory levels result from the severity of the winter season. For example, last year's mild winter (starting from January 2006) is plotted below in RED, which happens to be above the average since 2002.
Figure 1
The 2002-2003 El Niño lead to colder temperatures and a greater drawdown in inventories. The El Niño pattern leads to colder/wetter conditions in the East and warmer/drier conditions in the West; this is significant for two reasons. First, El Niño's result in colder temperatures is in regions that make up the greatest percentage of the national draw down in inventories (East) and warmer temperatures in the regions that make up the smallest percentage of national draw down in inventories (West). The East on average (2002-2006) represents 67% of the national drawdown and the West accounts for only 11%. This means that the colder temperatures in the East will have a significant impact on inventories while the warmer temperatures in the West are not that significant when comparing their percent of the national draw down in inventories relative to the East.
Moreover, both the East and the Producing Regions (Mid-West to East Coast) experience a greater percentage in the drawdown of their inventories. For example, the average winter drawdown since 2002 in Eastern natural gas inventories is 67% from Peak levels in November and 46% for producing regions. In the 2002-2003 El Niño, the winter draw downs for the Eastern and Producing Regions were 83% and 75% respectively, a large increase from an average winter drawdown. Nationally, the average is a 59% decline while the last El Niño saw a national draw down of 77% from November levels. (The tables and charts are given below.)
| Table 1 | ||||
| Average Nat Gas Draw Down from Peak to Trough Inventories from 2002-2006 | ||||
| Region | East | West | Producing Region | Total Lower 48 |
| November (BCF) | 1883 | 417 | 899 | 3199 |
| April (BCF) | 613 | 206 | 483 | 1302 |
| Draw Down (BCF) | 1270 | 211 | 416 | 1897 |
| % Decline from November | 67% | 51% | 46% | 59% |
| % of Total Draw Down | 67% | 11% | 22% | N/A |
| Table 2 | ||||
| Nat. Gas Draw Down in the El Nino Winter of 2002-2003 | ||||
| Region | East | West | Producing Region | Total Lower 48 |
| November 2002 (BCF) | 1818 | 412 | 838 | 3068 |
| April 2003 (BCF) | 311 | 172 | 213 | 697 |
| Draw Down (BCF) | 1507 | 240 | 625 | 2372 |
| % Decline from November | 83% | 58% | 75% | 77% |
| % of Total Draw Down | 64% | 10% | 26% | N/A |
If we do in fact have an El Niño winter pattern develop this winter that has similar affects as the 2002-2003 one, it will significantly affect inventory levels despite the fact that we are currently above "average levels." What I want to focus on is not the "average levels" but compare where inventories are now compared to what they were in 2002 as the El Niño set in. Looking at the chart below, the 05-06 season in RED begins from September 2005 (left) and ends in September 2006 (right). The 2002-2003 season in BLUE starts from September 2002 and ends in September 2003. Looking at the September 2006 levels (far right, RED) at just above 3000 bcf is only slightly above the September 2002 levels (far left, BLUE) that were slightly below 3000 bcf. See chart below.
Figure 2
The point here is that though analysts keep touting that we are above "AVERAGE LEVELS" for natural gas inventories, we are at "COMPARABLE LEVELS" to the beginning of the 2002-2003 El Niño which saw a huge draw down in natural gas inventories as seen by comparing the 02-03 and the 05-06 paths above in Figure 2.
The El Niño of 02-03 lead to a large draw down in natural gas inventories and the price of natural gas jumped from a low in September of 2002 at $3.13 to a high of $9.14 in February of 2003, a jump of more than 192% (Figure 3). This is a far larger move in natural gas compared to the 2005-2006 season, which saw a bottom in natural gas in September of $10.65 to a peak in December of $15.48, a 45% gain (Figure 4).
Figure 3
Figure 4
With natural gas futures currently trading below $6 mmbtu and with Henry Hub spot natural gas trading at $4.03 mmbtu, natural gas companies may experience a lift this coming winter if the forecasted El Niño plays out this winter. Last year it was the hurricanes that drove natural gas prices higher while this year Mother Nature may come in another form to send the commodity higher. Time will tell.
Today's Market
The Mortgage Bankers Association of America (MBA) released their weekly mortgage applications survey which showed mortgage demand increased last week, as purchase applications rose strongly (up 7.6%) and refinance applications surged (up 17.5%). Falling interest rates have lead to a rebound in mortgage applications as the fixed rate mortgage (FRM) has fallen 62 basis points since late June while the adjustable rate mortgage (ARM) has fallen 55 basis points. Falling interest rates lead to a 3.3% increase in the MBA purchase index for September, the largest monthly increase since March of 2005. However, Moody's Economy.com expects the housing market to remain in a weakened state over the course of the next year as stated in their report, "Housing at the Tipping Point: The Outlook for the U.S. Residential Real Estate Market." Moody's Economy.com expects existing home sales to continue to trend down through the fourth quarter of 2007, with new home sales bottoming soon afterward. Meanwhile, refinance activity is likely to stabilize with interest rates in the near term.
"The housing market downturn is in full swing," said Mark Zandi, chief economist of Moody's Economy.com. "To date, the housing downturn has been generally orderly and is characterized best as a correction and not a crash. Whether the housing correction unravels into a crash will largely depend on the secondary or indirect effects from the housing downturn."
Those effects include the impact of the downturn on the job market, on consumer spending via the housing wealth effect, on lending institutions, and on the global financial system as mortgage credit quality weakens, Zandi said.
"The larger these effects, the more serious the blow to the broader economy, which, in turn, will reverberate back onto the housing market," said Celia Chen, director of housing economics at Moody's Economy.com.
The unwinding of the long housing boom began in the summer of 2005 has become more dramatic with the departure from the market of the "flipper," the so-called buyers who intend to re-sell their properties quickly at a profit. "All of this has seemingly occurred overnight," Zandi said.
In other economic news, factory orders were unchanged in August relative to July, which was better than expected as economists were forecasting a 0.2% decline. Both durable and nondurable goods were unchanged last month while inventories posted a 0.4% increase.
Figure 5
Source: Econoday, www.econoday.com
The Institute for Supply Management (ISM) released their non-manufacturing report for September, which showed business activity slowed sharply, with the business activity index falling 4.1 points to 52.9, a greater plunge than analysts were expecting. The index is now at its lowest point since April of 2003, although the prices paid index report was encouraging, which fell to 56.7 from 72.4 in August.
Figure 6
Source: Econoday, www.econoday.com
Despite the lackluster economic news the markets continued their march upwards as the Dow Jones Industrial Average broke the 11,800 mark rising to 11,850.61, finishing near the high of the day. A surprise rise in crude inventories and news that Saudi Arabia said it wanted to keep oil prices lower helped lift the markets.
All of the broad market indices were up, with the DJIA posting a triple digit gain of 123.27 points to close at 11,850.61. The S&P 500 was up 16.11 points to close at 1350.22, and the NASDAQ was also up, rising 47.30 points to close at 2290.95. The 10-year Treasury note yield fell to 4.565%, and the dollar index posted a small gain on the day, rising 0.12 points to close at 85.83.
Overseas markets were mostly up except for the Nikkei which was down 0.98%. The big movers were Brazil's Bovespa and Mexico's Bolsa posting gains of 3.60% and 2.20% respectively. France's CAC-40, Germany's DAX Index, and London's FTSE 100 were all up, rising 0.70%, 0.90%, and 0.50%.
All ten S&P 500 sectors were up on the day with energy starting off initially down on inventory data before reversing course and finishing as one of the strongest sectors at the close. The largest gain came from the technology sector up 1.96%, followed by energy and consumer discretionary, up 1.54% and 1.45% respectively. The weakest sectors on the day were materials and utilities, up 0.17% and 0.42%.
Have a pleasant weekend,
Chris Puplava
© 2006 Chris Puplava
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