Natural Gas Dilemma: Investment Fruition or Price Freefall? (CHK, PDE)

Investors in natural gas are on the horns of a dilemma: Will global demand really continue apace, with LNG investment around the world bearing fruit while prices remain at historic highs (above $6) or is the huge inventory glut we're now seeing just the beginning of a return to the historically low (sub-$4) NG prices that led to its popularity in the US?

There are good arguments on both sides. The Washington Post had a good article on Friday morning on the glut, implying that investors right now are really assuming a hot summer, cold winter, and active hurricane season. It looks to me like they're talking about investors in futures, since Chesapeake (CHK) and most of the other energy producers I'm familiar with have hedged a lot of their NG production at prices significantly higher than today's spot rate. The most important part of this article for those who invest in NG companies, in my opinion, is the reminder that the expiration of contracts is one of the most critical moments -- if hedges or contracts are due for renewal when prices are high, no harm done; but if prices have bottomed thanks to this current supply glut, companies may be forced to sign supply contracts at much lower rates.

But in the longer term, as Bernanke said the other day in what seemed to be his thousandth speech of the year, it seems foolish to assume that energy demand will dry up or that supply will materially increase. With energy companies routinely being too conservative -- as we saw in 2004 when Exxon and all the big oils were priced as if oil would return to $20 a barrel -- I'm inclined to believe Bernanke's assessment that use of fossil fuels will continue to climb as the world industrializes, with at least several years before improving efficiencies can overcome increased overall demand to reduce the usage rate.

The safe bet, in my opinion, is to stay out of any short term (less than a year) gambles on the price of natural gas -- that's just a bet on weather -- and take advantage of any weakness in the natural gas spot rate to pick up shares in profitable energy companies with good long term potential, and plan to hold them for at least a couple years. For me, that's drillers SeaDrill and possibly Pride International (PDE), and natural gas developer Chesapeake through their preferred stock [CHK-D].

This worked well for me in the oil runup of 2004 and 2005 with low-priced oil companies like Petrobras, Statoil (STO) and PetroChina (PTR), as company and analyst expectations continued to underplay the increase in demand while oil climbed from $30 to $70. While I don't expect that kind of dramatic change in natural gas, I do think we're underestimating demand and letting solid, profitable companies like Chesapeake trade too low. Your mileage may vary.

CHK 1-yr chart:

Comments

[Gojijoan]

Loved your article. I also agree that energy will get goobled up because many countries ( China, India, Russia ) are trying desperately to catch up with the western world. Everybody wants our lifestyle. Can you blame them. Capitalism gets rid of poverty. Thanks for reading. Joan in Canada.