Can Natural Gas and Crude Markets Keep Up?

Article excerpt

Lean natural gas inventories last fall led to a solid rally, This season's fundamentals look similar. Crude oil output has increased but so has demand. What's in store?

Energy markets have a way of letting the tanks run low and then panicking when not much fuel is left. In today's just-in-time inventory market, there is little reason to stock up early for any season, and this creates the volatility traders love. This winter season may provide just that in the natural gas sector, where natural gas inventories still are lean at the start. Last year, inventories were limited, and a fall rally boosted prices to more than $4.60 per million Btu.

Meanwhile, the crude market continued to chug along this summer pumping out more oil, but road-hungry motorists scooped it up in the form of gasoline. Heating oil stocks look strong, but a cold snap early always can send markets skyward. Here's how the fall picture in energy looks.

Fire it up

Early fall fundamentals indicate that natural gas storage [TABULAR DATA OMITTED] levels are a bit light entering the winter season. As was the case last year, natural gas stocked up early in summer, and now the industry is waiting to see what Mother Nature may bring this winter. Working natural gas inventories are just 108 billion cubic feet ahead of last year, which was considered low. Last year's wait- and-see approach produced a rally from early September lows of $1.86 to a high in December of $4.62. Some say the rally was caused by large hedging positions taken by large utilities, which were boosted by speculators. Others say lean inventories created a market ripe for a squeeze.

Natural gas "is in the best position for a rally," says Tim Evans, senior analyst for Pegasus Econometric Group in New York. In late August, open interest was at an all-time high, indicating a possible run. Evans does not expect another spike like last year, but he does see a rally to the $3.12 level. Beyond that, his technical indicators show resistance at $3.59.

"Natural gas has a tendency to run further and faster in both directions than other energies," he says, cautioning not to expect another rally to $4.62. "History doesn't like to repeat itself two years in a row."

But cautious bullishness is about all you'll find in natural gas this fall. M. Nizam Sharief, director of energy research at Hornsby & Co. in Houston, is a bit more guarded about an extended rally.

"Year-to-date demand has not been that great in natural gas, but it has been volatile," Sharief says. "More natural gas production is supposed to come on line, so that's a factor as well."

Sharief forecasts natural gas to range between $3.00 and $3.50 this winter. Others peg natural gas as low as $2.30-$2.65.

Warm winter?

But what if there is no winter? El Nino, the weather pattern that has warmed a huge span of water off the coast of South America, may create warmer weather for parts of the United States this year. Most meteorologists expect, however, that more precipitation rather than warmer temperatures will be the most significant result of El Nino in the Midwest and Northeast regions. While traders do not give a great deal of credence to El Nino's potential effects on the market, some concede it could dampen rallies.

But a report by Richard Redash, an energy analyst with Prudential Securities, says regarding the effects of El Nino, "Historically, El Nino's peak impact has been felt in the United States from November through March, coinciding with the months in which natural gas and heating oil futures are typically the most volatile."

For the most part, however, energy watchers aren't about to credit the weather pattern prematurely.

"I don't see how it'll be a huge factor," says Bill Edwards, president of Edwards Energy Consultants in Houston.

Alan H. Levine, energy expert from Dean Witter in Washington, says "the El Nino event is bearish and is limiting rally expectations. …