Natural Gas: Short Term Bear, Long Term Bull

Funny how times can change in the world of oil/gas… even scarier is the pace at which they can change. Natural gas is trading at about 70% lower than its peak of close to $14 per 1000 cubic feet in just 8 short months. This is in spite of the fact that we are just finishing the North American winter heating season. It’s hard to think how low it may go in the summer, especially if this summer proves to be relatively cool (reducing the demand for Natural gas to produce electricity).

Further aggravating the problem is the fact that there is an awful lot of supply coming onto the market. This is especially true in some of the fields that are now being tapped for the first time with the creation of new drilling/fracturing techniques. These include some of the shale areas such as Barnett, as well as the Montney play in northeast BC / North-West Alberta in Canada. Finally, extra storage is being built all the time for LNG (Liquified Natural gas) in the US/Canada ports. One has to wonder if some of the excess supply in other parts of the world might end up in these places, further adding to oversupply.

In response to the lower prices, producers have scaled back dramatically on drilling new holes. Recent numbers from Baker Hughes shows that rig utilization in the US is down about 40% from the peak last summer. The numbers are worse in Canada, where utilization is down by close to 75% for the peak in late 2005.

So…things look bleak for the short-term for Natural gas. But, what does this say for the long-term (in my books, this means 3-10 years)?

Some things to make me a long-term bull on Natural gas:

1) Oil Sands

• Even as an Albertan who is benefiting financially from the development of the oil sands, I’m still a bit amazed that we are burning clean natural gas to produce oil.
• For those of you who aren’t aware, natural gas is used as a fuel to heat the steam to liquefy the oil sands into a liquid form. It is then often used as a fuel source for many of the generators that refine it into usable gasoline and other liquids.
• Natural gas use in the oil sands is projected to jump from 700 million cubic feet in 2006 to a projected 2+ billion cubic feet by 2015 (this is according to The National Energy Board). With the recent slowdown in the oil sands, it may take an extra year or two to get to this level, but in any case, the rise is substantial.
• There has been talk of using nuclear power for this process, but with the long planning / construction time needed for these projects, it doesn’t look encouraging.

2) Electricity Generation

• Currently, a little less than 20% of the electricity used in the US is produced through the burning of natural gas. This percentage is not likely to go down anytime soon, and may in fact rise as some of the older coal plants are shut down.
• With the total world-wide electricity use expected to double (from 13.9 trillion kilo-watt hours in 2001 to 24.7 trillion kilo-watt hours in 2025), it can easily be projected that natural gas use in electrical production will see a significant rise.

3) Fuel for Vehicles

• I can see it now…this point is going to gather more attention that it should. I don’t want to start a debate on whether we should be using natural gas to power our cars.
• I’m not fully convinced that we will see a tremendous growth in the use for natural gas for vehicles, but considering the aggressive initiatives taken by President Obama, it could very well happen. At the very least, the use of natural gas for vehicles should not decline any time soon.

4) Oil vs. Natural Gas

• It is generally recognized that a barrel of oil is equivalent to about 6000 cubic feet of natural gas. I’ve seen this number as low as 5400 to as high as 9000, depending on a lot of factors. However, 6000 is generally recognized by most in the oil industry.
• Using the conversion, oil is currently trading at over 12x the price of 1000 cubic feet, meaning that you would get twice the “bang for your buck” using natural gas as a heating/energy source than oil.

Many facilities in the industrial space are capable of switching between the two sources, depending on availability and price. If this spread continues for much longer, natural gas will become the preferred choice.

5) Industrial Use

• Natural gas is used extensively in many industrial areas from chemical production to fertilizer to the production of steel and other metals.
• With the recent economic turmoil, there has been a significant reduction in the production of many of these items. This won't last forever.
• Once there is a sign of economic recovery, many plants will fire up at full capacity immediately (as much of their inventory will have been depleted).

6) Hurricane (fill in the blank)

• Most of the points above are longer-term catalysts to a recovery in the price of natural gas. This one would not fall under that category.
• With a significant portion of natural gas production either done in the Gulf of Mexico or stored there, a significant hurricane strike to Louisiana, Eastern Texas or to the Gulf platforms themselves could put an immediate lift in natural gas prices.
• This would be even more dramatic, as it would be more difficult to “turn up production” with many idle rigs.

So, I am definitely bullish in the long-term on natural gas. To play this, I have strong positions in natural gas producers (EnCana (ECA) and Canadian Natural Resources (CNQ)), as well as Natural Gas Servicers and Rig Owners (Transocean (RIG), Weatherford (WFT) and Schumberger (SLB)) and Energy Infrastructure (TransCanada (TRP) and Hanwei Energy Services).

Disclosure: Long ECA, CNQ, SLB, WFT, RIG, TRP, HE-Toronto.

Comments

[Mad Hedge F...:]

I think you're spot on. 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 07:10 AM

[Michael Fit...:]

agressive actions by Obama? unfortunately, this is definitely not true with respect to natural gas transportation. the president, congress, and the american people have yet to figure out that natural gas transportation is key to our foreign oil addiction, environmental woes, high energy bills. it is abundant, cheap, and clean. we could reinvigorate and reindustrialize america with a robust natural gas transportation problem. instead, we stay addicted to foreign oil, fund both sides of the "war on terror", keep spewing CO2 and particulates into the air, and stay on the peak oil economic yo-yo. meanwhile, the low prices of natural gas are causing another washout in the oil patch similar to the 1980's. it's a damn shame. big oil and coal interests have stacked the deck against natural gas transportation, and the nation is and will continue to pay the price.

Apr 02 08:13 AM

[longoil:]

While it is possible to replacing natural gas for generating the heat needed in oil sands processing, it cannot be replaced entirely. Natural gas is still needed as a source of hydrogen in final stages of oil sand processing. See the link below:

www.cos-trust.com/oper...

Apr 02 08:27 AM

[happycajun:]

Fitzman - Like I've told you before - Nat Gas just ain't novel enough for the Obamans to get charged up about, and it still releases CO2 & is a "finite" resource - all negatives to the administration, so they are going for the homerun, to leap ahead of fossil fuels entirely. I keep hearing "Moore's law" (after Intel co-founder Gordon Moore) recited for the proposition that "technology" results in a doubling of performance every 18 months, at one half the cost. Right. If this were true, we'd all be flying to the moon on tiny rockets purchased at walmart for $1.98.

I have seen a lot of trucks hauling large diameter epoxy coated line pipe (20+ inch stuff) and a lot of large diameter Cameron Ball Valves (in sets of identical units on trailer rigs) in north Louisiana and North East Texas - so some pipeline construction is underway. My thoughts are that the basic economics and "free market" (such as it is - the ol' invisible hand) will make nat gas rise to the occassion. The trip will be bumpy though, and will be in spite of, rather than because of, anything the current administration does.

Longoil - in principle, there is no reason that nat gas is needed to create hydrogen - in refineries, they crack the long chains to the point that only carbon is left from the hydrogen-carbon molecules - hence petrocoke byproduct. Way back in the old days, in a former era of oil glut - conoco had a major liquid gasification project to produce pipeline quality gas from abundant, cheap crude oil. (this was in the late 60's, early '70's). HOWEVER, it is probably more economical to use natural gas for the hydrogen source than to crack it from the raw bitumen, and produces greatey yields of syncrude.

The huge dip in oil and nat gas prices over the last nine or so months will only make the return to tight supply all the more abrupt and painful...

HC

Apr 02 09:21 AM

[ArtfulDodger:]

Excellent article, Mr. Larry Bellehumeur. Very good reasoning for the long position on NG.

Very good points from you too, Mad Hedge Fund Trader.

Fitzy, here you are over here throwing in all your whacked out, kooky views. Now it's a conspiracy against NG by that old bogeyman, Big Oil, and you've added Big Coal. God help us!

I told you Fitzy: they'll love you on the Huffington Post blog!

Apr 02 10:12 AM

[Larry Belle...:]

As always, thanks to everyone for taking the time to read my article.

Mad Hedge -- I suspect that it may bottom out closer to $3.00 before we are done. Some renewed Economic optimism may help to raise it temporarily, but doubt that it sustainable for too long. I do like Devon Energy as well, mainly because they seem to be a very well run company. Disclosure - No position in DVN

Fitz -- As I mentioned, I am not sure if we will ever see a boom in Nat Gas usage for vehicles. Proponents of it include Boone Pickens, who has done some advising for Obama, but it would be too much to create the necessary infrastructure to match the ease of using Oil. A possible spin-off for Nat Gas would be if the move was towards Plug-in Hybrids took hold, as they would create a greater need for Electricity production. This would have some indirect effect on increasing Nat Gas use.

LongOil -- There are many people who are much smarter than I when it comes to Chemistry, so I will take your word for it. The reality is that it will be at least 2018-2020 for any power to be generated by Nuclear in the Oil Sands (and this is assuming that all of the Government regulations can be done quickly....no sure thing).

Cheers
Larry

Apr 02 11:10 AM

[Larry Belle...:]

Think I need more coffee....my comment to Mad Hedge should read "I doubt that it IS sustainable for too long"

Apr 02 11:14 AM

[Mmarrkk:]

Fitz: Exactly who is Big Oil that is holding down NG? I just don't see that because all of the "popular villains" in Big Oil (Exxon, ConocoPhillips, Chevron, Shell, etc) also have huge natural gas positions. In fact, if you look at their balance sheets and reserves ledgers, most have close to parity NG vs crude oil, or getting close to it. And revenues from nat gas are pretty substantial as well. And on an "after-op cost" basis, nat gas is infinitely easier to market than crude oil. Costs way less to get out of the ground, don't have the refinery costs, etc. So I'm not sure I plug in with the Big Oil is holding Nat Gas back theory. Now Big Coal...that's a whole different story. Hency Aubrey and CHK's fight against coal-fired power generation in OK.

Apr 02 01:47 PM

[clarkenn:]

Here, here!


On Apr 02 08:13 AM Michael Fitzsimmons wrote:

> agressive actions by Obama? unfortunately, this is definitely not
> true with respect to natural gas transportation. the president, congress,
> and the american people have yet to figure out that natural gas transportation
> is key to our foreign oil addiction, environmental woes, high energy
> bills. it is abundant, cheap, and clean. we could reinvigorate and
> reindustrialize america with a robust natural gas transportation
> problem. instead, we stay addicted to foreign oil, fund both sides
> of the "war on terror", keep spewing CO2 and particulates into the
> air, and stay on the peak oil economic yo-yo. meanwhile, the low
> prices of natural gas are causing another washout in the oil patch
> similar to the 1980's. it's a damn shame. big oil and coal interests
> have stacked the deck against natural gas transportation, and the
> nation is and will continue to pay the price.

Apr 02 11:21 PM

[David White:]

Good article. It probably is a good time to get out of Nat. Gas companies. They have run up in the current rally. It is probably a good time to get out of oil services (they do gas too). They have had a big run up lately. The job numbers keep getting worse. The unemployment rate is expected to climb above 10% this year. Those unemployed people won't be using as much oil/gas. The EIA has decreased its estimates for oil use this year already. Further demand estimate decreases may be coming. Market gossip believes the IEA will soon issue another lowered forecast for oil and gas. The number of land based rigs being used in the US and Canada this year is way down. The price of natural gas makes it prohibitively expensive to drill for natural gas in the Gulf. Even if the oil service companies have long term contracts, the prices of oil and natural gas have to be hurting them this year.

We may see another rally as we enter the summer period. The summer has hurricanes and summer driving season. However, to set that rally up, the oil service stocks likely have to go down in the near term. Shorting them may even be a good play. However, selling them at what is likely very close to the end of the current rally seems a good strategic move. Then you can buy them back again as we get closer to summer to ride the next rally up (provided there is one).

I don't mean to rain on anyone's parade, but the rally has already risen about 25% off the lows. It is unlikely it will keep going straight up without a pullback. Plus you have to keep in mind that the mark to market changes will not be used for the Q1 results. Earnings season for Q1 seems likely to be particularly ugly. It is approaching next week. Alcoa is probably the official starter when is reports Tuesday after the market closes. Add to that the housing price numbers (-19% year over year). This will likely increase foreclosures as more mortgages will be underwater (and more people will become unemployed) Add the fact that commercial real estate is supposed to be in trouble this year. Add that the consumer credit problems (defaulting credit card debt) are supposed to shoot through through the roof this year (remember again the rising unemployment). This shoudl all translate into a big decrease in demand for oil and natural gas. People will be pinching pennies.

On the flip side some might say the trend is your friend. If you believe the oil, natural gas, and oil service stocks will continue to go up in the near term, stay in them. If you want to be conservative, now might be a good time to get out of them for the short term. You can then likely get back in at a lower price. At worst you will have made a profit on the current rise upward to this point. At worst you will miss the last bit of the current rally. How many of you expect the current rally to be a 50% rally without a significant pullback. I don't.

As for Obama's comments about this being a turning point for the economy, he is paid to act confident. That doesn't mean everything he says will immediately happen. The forecasts are still for growth in unemployment (and we are seeing this). This leads to decreases in demand for goods that are not absolutely necessary. A lot of the driving we do is not absolutely necessary. It is not absolutely necessary to heat our houses quite so much. With summer coming, we won't have to heat them at all. Recession bottoms are often tracked by the unemployment numbers. Since these are still growing at this point, most people would rationally say we have not hit bottom. When these numbers start to reverse (for at least a couple of months), then we can rationally say the recession has bottomed. Irrationally optimistic speculation seems unlikely to make one rich.

Apr 03 11:45 AM

[David White:]

If you wonder how the Q1 earnings are going to turn out, all you really have to do is look at the job loss numbers. Companies aren't laying off huge numbers of people because they are doing well. Their Q1 numbers will reflect the fact that they in total are doing very poorly (some much worse than others). Plus they have to add all the costs associated with laying off people to their poor results. Don't kid yourselves Q1 results will stink!!! Obama is a great communicator. He does tend to instill confidence when he speaks. Still facts are facts (and he has not used many hard facts in his recent speeches).

Apr 03 02:09 PM

[David White:]

By the way the IEA announcement is scheduled for April 10. If specualtion about the decreased demand estimates for oil are correct, this should push oil and oil service stocks down considerably. Of course, they may already be headed down before then (although they are clearly still going up so far today). Alcoa earnings may signal the end of the current rally. They have had huge layoffs. The GAAP numbers will be very ugly indeed.

Apr 03 02:12 PM

[David White:]

Let's not forget that two major car companies are on the verge of declaring bankruptcy. Chrysler's deadline is in about a month. GM's is in about 2 months. If one or both goes into bankruptcy (even an orderly one), the unemployment numbers will spike dramatically. The cascade effect from GM and Chrysler failures could be more than 1 million jobs. This is only one of the truly bad scenarios hanging over our heads at the moment.

Add to this some companies are still offshoring jobs. IBM quietly announced that they were moving 5000 jobs offshore. I can't see this huge bout of optimism at the moment. If we can get by the GM and Chrysler situation relatively unscathed, I might be more optimistic. This rally is just market craze at its best.

Even China which is supposed to be doing so well has been cutting down on dry bulk imports lately. Just look at the performance of the BDI over the last few weeks. The BCI spot average, which was up near $40,000 just weeks ago, is today down to $17,107. Admittedly the iron ore price agreements for this year still haven't been signed. Still this kind of statistic does not fill one with confidence that the recession is nearing an end (or that China is leading us out of it). A lot of the shipping companies are having serious loan covenant problems. Some are going bankrupt.

I would strongly advise people to be more cautious. The current unbridled optimism has lost touch with reality. Hand waving does not a healthy economy make. We saw what happened Monday when the government only gave GM and Chrysler extensions on their deadlines. What might happen if either or both really went into bankruptcy.

I am not saying everything should be going down and down and down. I am just saying that there is not enough substance to this rally to make it reasonable for stocks to be going up and up and up.

Apr 03 02:50 PM

[Blizzardbaum:]

I am new to oil/natural gas and I was hoping someone could answer a question I have about a comment made in this article. What kinds of companies/facilities in the industrial space have the ability to switch between natural gas and oil depending on price and availability? How long of a runway do these companies need to make the switch, or can they typically do it on a time?

Any examples would be appreciated, as would any sources where I could learn more about this. Thanks.

Apr 03 04:03 PM

[Blizzardbaum:]

I am new to oil/natural gas, so please forgive me if this is a stupid question. What kinds of companies/facilities are capable of switching between natural gas and oil depending on price and availability? What kinds of operations typically have this kind of flexibility? How long of a runway do these companies need to make the switch, or can they turn on a dime?

Thanks in advance for answers, and also for any advice on where I can learn more about this.

Apr 03 04:06 PM

[Larry Belle...:]

Hello Blizzard....

Some of the Industrial Companies (such as in the production of Steel, or in the production of Steam for the Oil Sands) often have the ability to change the input fuel source that they use. I couldn't answer how fast they could change exactly, although it wouldn't be that long. It would require some slight overhaul.

The reality is that Nat Gas is still the preferred method for these types of programs long-term (as it has less Carbon Footprint), so there is a gradual change to this anyways..

Hope this helps....I write a lot of articles on Energy, so hope to see you on future postings....

Larry

Apr 04 07:25 PM

[Blizzardbaum:]

That is very helpful, thank you. Can you provide a specific example or two of a company that has this capability so I can research it further?

I will look out for future articles you write. Thanks.


On Apr 04 07:25 PM Larry Bellehumeur wrote:

> Hello Blizzard....
>
> Some of the Industrial Companies (such as in the production of Steel,
> or in the production of Steam for the Oil Sands) often have the ability
> to change the input fuel source that they use. I couldn't answer
> how fast they could change exactly, although it wouldn't be that
> long. It would require some slight overhaul.
>
> The reality is that Nat Gas is still the preferred method for these
> types of programs long-term (as it has less Carbon Footprint), so
> there is a gradual change to this anyways..
>
> Hope this helps....I write a lot of articles on Energy, so hope to
> see you on future postings....
>
> Larry

Apr 05 04:56 PM