Natural Gas: Production Is Key

From a commodity perspective this year, we have been primarily focused on copper and oil over the last few months. This is driven both by our re-flation thesis, under which global priced commodities such as copper and oil benefit, and also our bullish stance on China, which is the home of the majority of incremental demand for these commodities globally. Lately, natural gas has started to come on our radar screens, but for vastly different reasons.

Unlike its use of oil, the United States is largely self sufficient in its use of natural gas. In 2007, the U.S. produced 19.3 billion cubic feet annually and consumed 23.1 billion cubic feet, for a net import number of 3.8 billion cubic feet. More than 95% of the net import number for natural gas comes from Canada, which in aggregate makes North America highly self sufficient in its production and use of the commodity. Unlike oil, the continent is not a net importer for natural gas.

The implication of this is that natural gas is a commodity that is priced much more on basic supply and demand versus oil which is priced partially on natural supply and demand, but also based on geopolitical risks and actions of regional cartels, primarily OPEC.

In the United States, ~28.7% of natural gas is used in the economically sensitive industrial sector. In economically weak times, demand from the industrial sector declines. In late 2008, it was a perfect storm for natural gas with a weak economy leading to declines in consumption combined with a natural gas production profile that was increasing at an accelerated rate due to high natural gas prices, which prompted more drilling, and due to a number of the large shale plays coming online. In the table below, y-o-y growth in natural gas production in the U.S. is summarized (click to enlarge):

The key take away from the table above is that U.S. natural gas production growth on a y-o-y basis was well above its historical norm for the last 6 months of 2008. We calculated the CAGR for U.S. y-o-y production growth from 1990 to 2008 and the CAGR was 0.80%. The CAGR in consumption for that period was 0.96%, which implies that historically, at least for the last two decades, the industry acts relatively efficiently in terms of production additions. This 5.4% growth that we witnessed in the last 6-months of 2008 was well above historical norms. Not surprisingly, gas in storage is up 372 Bcf, or 22.4% y-o-y, as of March 20th.

The key to thinking about the inflection point for natural gas from a supply and demand perspective is to determine the rate of decline in drilling, which will lead to declining production that will push the market back into balance and obviously stabilize pricing. Over the next couple of weeks, we will be surveying some of our contacts in the natural gas fields of North America to get more perspective.

Comments

[BBorSC:]

Good article on the production side. What is missing is an analysis on the industrial demand side. We are coming off one of the coldest winters in probably 15 years (a check of the degree days would confirm this) so consumption from a household heating standpoint must have been higher than normal for this decade. But industrial demand for NG has fallen off a cliff as large plants have been idled.

An uptick in industrial demand for NG will signal a return of consumer demand. It's a complex equation with the coming on-stream of LNG terminals scheduled for the coming months, increased domestic supply and reduced demand. Doesn't look good for the price of NG. It is good however for industrial competitiveness of the remaining industries using NG (vs. global use of the commodity).

Apr 02 06:39 AM

[Mad Hedge F...:]

Good research. Natural gas ($NATGAS), which peaked at $13.50/btu last year, has become the red headed step child of the energy complex, plunging a gut churning 72% to a low of $3.75. To see demand this weak coming out of a cold winter is nothing less than stunning. The credit crisis has forced US companies like Chesapeake Energy (CHK) and Devon Energy (DVN) to scale back exploration, so the US rig count had dropped by half. The price collapse is welcome news for consumers, as NG is an essential raw material for making naphtha, fertilizer, and plastics and accounts for 20% of US electric power generation. It also is a favored fuel of the green crowd, as the only products of its combustion are carbon dioxide and water. The industry was making the leap from a domestic industry to a global one just the global recession punched it right between the eyes. The completion of six liquefaction plans in Qatar, Russia, Indonesia, and Yemen costing $48 billion is expected to boost global production by 25% this year, and more big plants are coming on stream in the near future. If I’m right, and those really are crocuses out there and not some florid hallucination, then it’s time to load the boat with NG.

Apr 02 07:12 AM

[tool:]

what will this all mean for the small coal bed gas companies like GST, QRCP, PINN etc. Will they all go bust?

Apr 05 07:46 AM

[Thomas J. G...:]

Natural gas has been on an incredible roller coaster. I did really well with domestic energy trusts and enjoyed it. But now natgas is below $4. Like oil, natgas had a lot of speculation. That Amarind... guy who blew up $4 billion and went to Canada. With people like him gone we're under $4.

Apr 07 05:52 PM

[Mistrofan:]

Natural gas peaked at $15.78 in 2005 (and was the first commodity that bottomed in Jan-2001 as was the first that makes new highs in 2005).


On Apr 02 07:12 AM Mad Hedge Fund Trader wrote:

> Good research. Natural gas ($NATGAS), which peaked at $13.50/btu
> last year, has become the red headed step child of the energy complex,
> plunging a gut churning 72% to a low of $3.75. To see demand this
> weak coming out of a cold winter is nothing less than stunning. The
> credit crisis has forced US companies like Chesapeake Energy (seekingalpha.com/symbo...)
> and Devon Energy (seekingalpha.com/symbo...) to scale back
> exploration, so the US rig count had dropped by half. The price collapse
> is welcome news for consumers, as NG is an essential raw material
> for making naphtha, fertilizer, and plastics and accounts for 20%
> of US electric power generation. It also is a favored fuel of the
> green crowd, as the only products of its combustion are carbon dioxide
> and water. The industry was making the leap from a domestic industry
> to a global one just the global recession punched it right between
> the eyes. The completion of six liquefaction plans in Qatar, Russia,
> Indonesia, and Yemen costing $48 billion is expected to boost global
> production by 25% this year, and more big plants are coming on stream
> in the near future. If I’m right, and those really are crocuses out
> there and not some florid hallucination, then it’s time to load the
> boat with NG.

Apr 07 11:04 PM

[jimboy:]

I don´t follow the last bit of your post - why "load the boat" with all this negative on both the demand and supply sides? The long term case for NG generally and LNG in particular is compelling but isn´t it a case of Paradise Postponed for the reasons you have described? Perhaps it would be more accurate to say "take your time and load your boats with quality NG exposure gradually as prices bump along or drift lower for the next few months". Enlighten me.


On Apr 02 07:12 AM Mad Hedge Fund Trader wrote:

> Good research. Natural gas ($NATGAS), which peaked at $13.50/btu
> last year, has become the red headed step child of the energy complex,
> plunging a gut churning 72% to a low of $3.75. To see demand this
> weak coming out of a cold winter is nothing less than stunning. The
> credit crisis has forced US companies like Chesapeake Energy (seekingalpha.com/symbo...)
> and Devon Energy (seekingalpha.com/symbo...) to scale back
> exploration, so the US rig count had dropped by half. The price collapse
> is welcome news for consumers, as NG is an essential raw material
> for making naphtha, fertilizer, and plastics and accounts for 20%
> of US electric power generation. It also is a favored fuel of the
> green crowd, as the only products of its combustion are carbon dioxide
> and water. The industry was making the leap from a domestic industry
> to a global one just the global recession punched it right between
> the eyes. The completion of six liquefaction plans in Qatar, Russia,
> Indonesia, and Yemen costing $48 billion is expected to boost global
> production by 25% this year, and more big plants are coming on stream
> in the near future. If I’m right, and those really are crocuses out
> there and not some florid hallucination, then it’s time to load the
> boat with NG.

Apr 08 09:16 AM