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Schork Oil Outlook: Bulls Hang Hopes on The Snow Miser

Stephen Schork, Editor, The Schork Report

Yesterday the EIA reported that working gas in underground storage increased to a record 3.837 Tcf for the week ended November 27th. The surplus to the previous record increased 8.2%. It goes without saying; an injection at this point in the season – through the fourth Friday of November – is bearish.  

This is only the third time since 1994 we have seen an injection this late into the start of the heating season. As a result, underground storage rose to a tenth consecutive record and the spot NYMEX Henry Hub contract for delivery into January sank to a life-of-contract low, 4.432.

As we close the books on the 2009 refill season, underground storage of working gas will enter this winter within 1.35% of estimated peak design capacity.  More to the point, storage in the West and GoM are each above estimated capacity, 3.3% and 1.4%, respectively.

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This report was the first bit of truly good news for the bulls in well over a year; the implication being that we are finally beginning to see the knock-on from industry efforts to pare gas output.

However, before the bulls pop the champagne corks they should consider what has transpired in the market since September. 

A lot of anecdotal information we gathered from speaking to clients back in September and October suggested that a good deal of production that was shut-in over the summer was sold into the NYMEX pre-winter rally.

… High-grading, i.e. the shuttering of production at the fringe (less productive, low return plays) is skewing the drop in the Baker Hughes count.  The graph in today’s issue of demonstrates how vertical drilling used to account for ˜60% of production, but that amount has now decreased to ˜35%; while horizontal/directional rigs have taken the lion’s share, it’s basically a complete reversal. 

The corollary to this is that since 2008 we’ve seen the amount of product produced by each rig increase almost 100%. That means the use of horizontal/directional rigs provides a higher yield and thus, we’ll need less rigs in the future.

If you’ll notice, the product per rig value is actually decreasing between 2005 and Sep 08, hitting a low point in the third quarter of 2006.  Not co-incidentally, 3Q ‘06 was the same time that we had the highest number of vertical rigs.  

In other words, there was an oversupply of inefficient rigs. This meant the rig count was increasing but production wasn’t, i.e. the vertical rigs increased the product/rig denominator without increasing the numerator accordingly.  Thus, when these vertical rigs were taken off-line, the amount of product per rig increased because products remained roughly the same but rigs decreased.

Therefore, high-grading means less is more (not to be confused with Wall Street’s beloved malapropism… less bad is good).... – October 9, 2009

Thus, it looks like the high-graders are back… not to mention our friends to the north.

The EIA monthly summaries provide a more accurate look at working gas storage levels than the weekly survey.

We normally expect the weekly surveys to overestimate the actual levels, for instance Q1 2009 saw the weekly report over-estimate true values by 13 Bcf, while June saw a 12 Bcf overestimation. But interestingly the surplus has been decreasing for the last several months: July’s overestimation was 3 Bcf, August’s 1 Bcf and, as of September, the latest data available, the weekly survey overestimated the actual working gas in storage by 5 Bcf.

In absolute terms the difference is small, but the key take away here is that an increase in true demand was not picked up by the weekly surveys. Savor the implication, not just for its positive impression of the economy but because we may not be able to analyze the error for much longer. The DOE has drastically improved accuracy in weekly vs. surveys, as demonstrated by the graph of absolute difference shown in today’s issue of .

The error has decreased from a 44 Bcf over-estimation in June ’07 to 0 Bcf in May ’09 i.e. weekly surveys nailed the true value exactly. Moving forward, we look forward to analyzing whether the error becomes a meaningless random walk with zero mean or returns to a predictable bias.

Bottom line, the market needs to see a delivery akin to the record 2.53 Tcf we saw in 2003 to expunge the glut.  However, at this point in the 2002/03 heating season, 216 Bcf or 6.8% of the opening balance had already been delivered. Meantime, as of last week we were still putting gas into the ground.

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Stephen Schork is the Editor of, and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

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