Natural Gas Will Rise Again: UNG and FCG Provide Two Ways to Play

The seven-year low in natural gas prices is possibly the opportunity of a lifetime. The decline has been attributed to several occurences:

1. A significant decrease in demand from the industrial sector

2. Increased output from a combination of oversees production

3. An increase in unconventional gas from shale deposits in Texas and Lousiana.

That said, it's no wonder why natural gas has fallen below the price of $4 over the last month.

Nevertheless, the outlook for natural gas is quite promising. According to the Energy Information Administration (EIA), the consumption of natural gas for 2009 is expected to fall to approximately 1.4% and rise about .6% in 2010. Moreover, Henry Hub spot prices, which averaged $4.65 per thousand cubic feet (Mcf) in February, are expected to average $4.67 per Mcf in 2009 and $5.87 in 2010. Over the long term, the EIA expects Henry Hub spot prices (in 2007 dollars) to reach $9.25 per Mcf in 2030. Additionally, other factors which can potentially increase the price upwards include natural disruptions of natural gas such as severe storms (hurricanes), and a surge in demand from industrials as a result of a faster than expected recovery of the US economy.

While renewable energy companies are expected to represent a larger portion of the U.S. energy portfolio over the next two decades, natural gas along with coal and oil, the three natural resources currently most prevalent, are still expected to meet 79% of U.S. energy supply needs, down from 85% in 2007. Clean energy from renewable sources like the wind, sun and ocean waves, while promising, is likely to take several years before it reaches a critical mass.

An alternative for investors to consider is natural gas. Yes, natural gas is a fossil fuel, but it does offer the advantage of having a cleaner reputation than oil. For those who are considering a stake in natural energy, examine closely the following ETFs:

1. The US Natural Gas Fund (UNG). For investors who desire to track the performance of natural gas in percentage terms, UNG is appropriate. For example, when the natural gas April 2009 futures contract recorded a 13.74% increase at 5:14 p.m. on March 19, the UNG ETF followed suit, closing up 13.33% for the day.

The ETF is roughly about .40 cents above its 52-week low of 14.10. The ratio of puts to calls coupled with an accelerating volume suggest that the May 15 strike calls might depreciate rapidly. This gesture is great for option writers. To that end, one can buy the underlying shares and write the May 15 Strike calls at approximately .90/contract.

2. The First Trust ISE-Revere Natural Gas ETF (FCG) is suited for investors who wish to invest in an ETF tied closely to natural gas stocks. The largest holdings in FCG include Quicksilver Resources (KWK), Linn Energy (LINE) and Petrohawk Energy (HK).

FCG's May strike price 10 or 11 offers the same intrinsic time value, depending on how conservative an investor wishes to be. For those who want the possibility of pocketing the intrinsic value in hope of having the underlying shares getting called away by options expiration, the May 10 strike is a better alternative. Conversely, if you desire to establish a holding position with a greater chance of holding the underlying shares past options expiration, the May 11 strike is better.

Disclosure: Author does not own any securities pertaining to the above mentioned companies.

Comments

[Ishortyou:]

well as it is all a matter of supply and demand currently the supply gain momentum last few years but with the economy ciris the demand specially from the industrial sector went down considerably, as the economy recovers in the next few years the demand will catch up and the prices of gas go up again.

Apr 14 07:31 AM

[Toeser:]

So, the EIA forecasts natural gas prices to double in the next 21 years when oil has ranged from about $35-147 per barrel over the last year. Why would anyone even care what they forecast? Darts would work better.

I am a big believer in natural gas, but the supply side scares me right now. It needs to become a significant transportation fuel for any serious upside right now.

Apr 14 08:14 AM

[Buck East:]

Do you anticipate a significant increase in demand from the industrial sector? And if so, what forces will create this demand? Also, do you forecast a decrease in supply from shale and other unconventional sources? Many Shale producers are well hedged and are drilling and producing more shale wells than ever at lower cost. Look at what RRC is doing in the Marcellus Shale, and Southwestern in the Fayetteville--not to mention all of the Haynesville-Cotton Valley production that could easily be brought online in N.LA. If prices edge up above the marginal cost of production, won't that just encourage ramping up more shale and flooding the market? Oh, I didn't even mention CBM. Also, foreign LNG suppliers who produce NG for zero cost will be dumping the stuff on the U.S. market. Alas, we are awash in gas and any small increase in prices will only incentivize more unconventional production and export, which will force the equilibrium way down. We're awash in gas.

Apr 14 09:11 AM

[Mad Hedge F...:]

It's got to be a buy here because were are so close to the shut in price of $3.50 where supply disappears. Natural gas ($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 $3.40. 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 14 09:33 AM

[Lara Crigger:]

You bring up some good ETF ideas, but another interesting play would be the MLPs running the pipelines and other NG infrastructure. They're not as dependent on the price of natural gas as much as the volume conveyed, so barring a super-sustained depression in demand, they're going to remain relatively stable for awhile. (We actually talked about this in detail a few weeks ago at www.hardassetsinvestor... and in our latest podcast, here: www.hardassetsinvestor....) Of course, MLPs have their own drawbacks, but they may be a good way to jump into NG, what with all the interest in infrastructure lately.

Apr 14 09:37 AM

[user 385544:]

"1. A significant decrease in demand from the industrial sector"

and i would say our current economic landscape dictates there will be no increase in demand anytime soon.

"2. Increased output from a combination of oversees production"

Could you please explain what you see in overseas production; back up this claim with data please.

(UNG) is a great or not so great idea at these levels. I think it depends on a persons investment time frame.

At this point it could be dead money for awhile. There is plenty of upside once we see a bottom or at the very least a base. That chart is ugly at this point.

Disclosure: I sold my position in (UNG) 3 days ago.

Apr 14 10:11 AM

[Larry House:]

Short-term natural gas and oil may not do much, but if one can just build positions to hold for a few years, I think one will be richly rewarded. They one thing that can keep energy low long-term is if we are in a depression for years. Short of that, natural gas and oil will rise again.

Apr 14 10:18 AM

[Ishortyou:]

you guys are probably right in that the it will take a long time for the demand to go up as the economy recovers, specially from the industrial sector but at the same time there is lot of supply work going on as we speak not so sure if the demand will catch up with the supply side of the equation, doesnt look exciting to invest in gas for now.

Apr 14 10:24 AM

[elliot_mllr:]

In terms of supply bear in mind that many unconventional wells have steep decline curves.

Apr 14 11:02 AM

[Jack Haddad:]

Thanks for your insights; I appreciate the data.


On Apr 14 09:33 AM Mad Hedge Fund Trader wrote:

> It's got to be a buy here because were are so close to the shut in
> price of $3.50 where supply disappears. Natural gas ($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 $3.40.
> 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 14 02:16 PM

[einstein p ...:]

With oil and natural gas prices at current levels, green projects such as wind and solar will require huge subsidies. Oddly enough, with gas prices at current levels, there is another opportunity to explore natural gas and expand it's role in gaining energy independence. I have been a buyer of LINE at 11 and up, along with several of the CANROYS. I do not see any real downside risk to the investment at this point and the risk reward is more than adequate considering the steady flow of distributions while you wait.

Apr 14 07:54 PM

[Jack Haddad:]

Lara, thanks. I'll examine them closely.


On Apr 14 09:37 AM Lara Crigger wrote:

> You bring up some good ETF ideas, but another interesting play would
> be the MLPs running the pipelines and other NG infrastructure. They're
> not as dependent on the price of natural gas as much as the volume
> conveyed, so barring a super-sustained depression in demand, they're
> going to remain relatively stable for awhile. (We actually talked
> about this in detail a few weeks ago at www.hardassetsinvestor...
> and in our latest podcast, here: www.hardassetsinvestor....)
> Of course, MLPs have their own drawbacks, but they may be a good
> way to jump into NG, what with all the interest in infrastructure
> lately.

Apr 15 01:06 AM

[pockyclips ...:]

Having just completed my tax returns, I'm less enthused about UNG.
Extra paperwork involved isn't worth it to me. Long term investors should look else where. Find a good NG stock or non hedged ETF.

Apr 15 09:30 AM

[Jack Haddad:]

There is an extra form called "1065", correct? It's no bid deal... the company send you the numbers.


On Apr 15 09:30 AM pockyclips 2020 wrote:

> Having just completed my tax returns, I'm less enthused about UNG.
>
> Extra paperwork involved isn't worth it to me. Long term investors
> should look else where. Find a good NG stock or non hedged ETF.

Apr 15 06:42 AM

[Jack Haddad:]

There is an extra form called "1065", correct? It's no bid deal... the company send you the numbers.


On Apr 15 09:30 AM pockyclips 2020 wrote:

> Having just completed my tax returns, I'm less enthused about UNG.
>
> Extra paperwork involved isn't worth it to me. Long term investors
> should look else where. Find a good NG stock or non hedged ETF.

Apr 15 06:43 AM

[Jack Haddad:]

There is an extra form called "1065", correct? It's no bid deal... the company send you the numbers.


On Apr 15 09:30 AM pockyclips 2020 wrote:

> Having just completed my tax returns, I'm less enthused about UNG.
>
> Extra paperwork involved isn't worth it to me. Long term investors
> should look else where. Find a good NG stock or non hedged ETF.

Apr 15 06:43 AM

[optionsgirl:]

I purchased AAV after it suspended the dividend and announced it is changing from a CANROY to a corporation. The share price averaged around $2.00 each. I think it has good exposure to both natty and oil sands. For that price, I can afford to wait and see how AAV performs through this transition.

Apr 15 09:20 PM

[Toronto Day...:]

strangely enough I picked up some HNU.TO (2x long) a few days ago thinking that natural gas can't stay this low forever... and now today HNU.TO is up 8%.

Apr 17 11:52 PM