In a market trend that is reminiscent of the price slump this past winter despite continued cold weather, natural gas prices have sagged, even as the run of hot weather persists. While strong air conditioning demand has soaked up a considerable amount of gas, the market appears to be concluding that the demand bounce is still not enough. For the week, the prompt contract shed 39 cents, to $4.31 per MMBtu. The forward curve continues to flatten, as rest-of-year prices slid 34 cents, to $4.53, and calendar 2011 slumped 17 cents, to $5.02. We suspect that $5.02 is well below the hedge targets sought by producers.

Our balances continue to show storage heading for another record fill this year. While hot weather could continue to absorb up to half of the gas that we had expected would displace coal, the bounce in power loads is not high enough to avoid a high storage inventory finish. To us, this means that gas must price at coal equivalents through the remainder of the injection season to balance the market. In other words, high prices would quickly shut off coal displacement, causing the subsequent weekly storage injection to surge, pushing prices back to coal-competitive levels. Conversely, a further drop in prices should price another wedge of coal out of the market, boosting demand. The market thus has a self-correcting feature that should keep near-term prices rangebound. Importantly, end-of injection season storage levels will be dictated, in part, by the level of coal displacement.

Eoin Treacy's view The advent of unconventional gas supplies such as shale, tight and sand gas have beleaguered natural gas prices as massive volumes flooded the market and demand was quickly satiated. Natural gas is the only energy commodity to have fallen back to anything resembling levels seen prior to the commodity secular bull market. In this respect unconventional gas is truly a game changer for the energy sector because it provides ample new supply of a clean burning, secure and efficient fuel, currently at rates competitive to much dirtier coal.

The fact that natural gas is now competitive with coal will help to put a floor under the market. At current levels, the economic viability of drilling is also a concern which will also help to support prices by reducing supply. So while prices are likely to remain characteristically volatile, the downside risk appears to be limited to the lower side of the developing base which is between $3 and $4. A catalyst in the form of a hurricane, increasing industrial demand or a greater emphasis on natural gas as a transportation and heating fuel are likely needed to prompt significant new bullish interest. In the meantime, the competition for dominance between supply and demand continues and prices are back in an area of potential support.