Three Reasons to Be More Bullish on Natural Gas than on Oil

There are several reasons to be more bullish on natural gas than on oil right now.

1. Chesapeake Energy Corp. (CHK) announced plans to cut natural gas production further while also resuming some oil production. When producing natural gas becomes uneconomical and enough production is cut, prices will eventually have to rise. If production of oil is resumed after being previously cut, then it likely means that the production of oil is becoming economical again.
2. The Oil/Natural Gas ratio is almost as high as it ever reached since 1994 (all the historical data I could find). When the ratio has reached the level it is near now, natural gas has always outperformed oil. This does not mean that natural gas prices rose, they just outperformed oil.
3. Industry insiders are confident that natural gas prices will rise. MarketWatch reports what Chesapeake Energy Corp. CEO Aubrey McClendon said at the Independent Petroleum Association of America.

McClendon said natural gas prices -- which have dropped to below $4 per thousand cubic feet from more than $13 during the height of the bubble -- will return to $7.50 to $9.50 possibly by the end of this year.

The higher prices will provide economic incentive for drilling to meet demand, he said.

He said he remains as confident of a price turnaround as he did in 1999, when commodity prices began a steady march upward for years, based partly on his assessment for long-term demand for fuel.

The easiest way to be long natural gas is by buying the United States Natural Gas Fund, LP (UNG) or the iPath Dow Jones-AIG Natural Gas Total Return Sub-Index ETN (GAZ). Their price performance is nearly identical, but the iPath ETN is much less liquid than the ETF.

Disclosure: Slight long position in natural gas through DJP

Comments

[scfranklin94:]

No need to get bullish on NG just yet; we'll probably hit the limits on storage by September, forcing massive shut-ins. Aubrey is dreaming if he thinks NG is going to be back to $9 by December. Most likely scenario is that gas declines to $2.50 by Sep/August and then that will be the time to buy. This coming winter will have record storage on hand, so even if it is as cold as this last one, prices probably won't rebound greatly until a year from now. If the winter of 2009-10 is a warm one, be prepared for an end-of-winter storage number of 2 Tcf or more, which will keep a lid on prices until 18 months from now.

So will NG prices go up in the long-term? Of course, but it might be a year to 18 months.

Apr 22 09:47 AM

[John Polomny:]

What about depletion and the collapsing rig count? The last time the rig count dropped this much the natural gas price advanced 80% over the following 12 months.


On Apr 22 09:47 AM scfranklin94 wrote:

> No need to get bullish on NG just yet; we'll probably hit the limits
> on storage by September, forcing massive shut-ins. Aubrey is dreaming
> if he thinks NG is going to be back to $9 by December. Most likely
> scenario is that gas declines to $2.50 by Sep/August and then that
> will be the time to buy. This coming winter will have record storage
> on hand, so even if it is as cold as this last one, prices probably
> won't rebound greatly until a year from now. If the winter of 2009-10
> is a warm one, be prepared for an end-of-winter storage number of
> 2 Tcf or more, which will keep a lid on prices until 18 months from
> now.
>
> So will NG prices go up in the long-term? Of course, but it might
> be a year to 18 months.

Apr 22 10:08 AM

[auto44:]

It seems to me that large discoveries of natrual gas, new drilling technics(horizontal drilling and fracing), and large shipments of LNG to our shores do not bod well for gas prices. With all the talk about foeign energy why hasn't the stimulus pakage created a way to make NG available as a motor fuel and money spent creating NG cars. All of this would tend to spur the economy and reduce reliance on foreign products and credit.

Apr 22 10:18 AM

[User 158739:]

when did that happen?


On Apr 22 10:08 AM John Polomny wrote:

> What about depletion and the collapsing rig count? The last time
> the rig count dropped this much the natural gas price advanced 80%
> over the following 12 months.

Apr 22 10:33 AM

[Buck East:]

scfrankilin: I totally agree. I'm even more bearish on prices, because LNG imports are going to be increasing in the next 2 years as import capacity is increased and the cost of producing NG by foreign suppliers is infinitesimal compared to Shale. If low prices force rigs to lay down, reducing supply and raising price, wouldn't the new, higher prices simply incentivize new drilling and production activity, increasing supply and lowering price?

Apr 22 11:09 AM

[jratl:]

$7.50 to $9.00 prices by the end of the year sounds high when the EIA 2009 average is estimated at $4.24/Mcf and that is down from $4.67 in March. Sure the price will be going up as inventories build in the fall, but with five year highs in inventory there is plenty of time to build a position. Last year's increased production and this year's industrial slow down will take a little more time to work off the inventory. Also, rig count figures can be deceptive on the supply side with the increased percentage of horizontal wells now in production.

Apr 22 01:37 PM

[jratl:]

Funny you should ask!
WASHINGTON, DC, Apr. 2 -- Legislation to significantly expand the use of natural gas as an alternative to conventional transportation fuel will be introduced, three US House members said on Apr. 1.
Known as the New Alternative Transportation to Give Americans Solutions (NAT GAS) Act, the bill also would create a new tax credit for automakers which produce natural gas and bi-fueled vehicles.

Send your congressman an e-mail and let him/her know how you feel about NGV.

On Apr 22 10:18 AM auto44 wrote:

> It seems to me that large discoveries of natrual gas, new drilling
> technics(horizontal drilling and fracing), and large shipments of
> LNG to our shores do not bod well for gas prices. With all the talk
> about foeign energy why hasn't the stimulus pakage created a way
> to make NG available as a motor fuel and money spent creating NG
> cars. All of this would tend to spur the economy and reduce reliance
> on foreign products and credit.

Apr 22 01:44 PM

[billp37:]

"The current situation is that about 45% (from 1,606 to 884) of U.S. rigs have been shut since September 2008. Drillers need to add more than 3.5 bcf/day to offset declines and this means that the gas production going forward will decrease, at a faster pace than demand. This will naturally in due time, lead to higher natural gas prices. Natural gas futures for delivery in January 2010 are trading at a 49% premium to the April contract."

safe-and-cheap.blogspo...

Apr 22 02:10 PM

[tuj:]

The bearish sentiments expressed are almost certainly right. Rig counts, LNG, storage issues; all are indeed major factors. The historical oil/gas relationship means nothing in the era of unconventional gas. The only bullish event would be a more-active-than-usual tropics season, which is not being forecast by anyone. New shale plays will be developed such that the initial decline rate is lower (as is IP) such that the decline will become more linear and keep the initial gas constrained. LNG vehicles may work on the fleet size, but as mass production, its DOA. There's simply no good distribution infrastructure, plus the tank sizes of CNG are quite large as opposed to LNG, which isn't practical at the vehicle level. Historical volatility shows that the market has never priced in such high volatility as now. Take that how you will; to me its largely bearish.

Apr 22 02:59 PM

[Cliff Wachtel:]

Good article. Looking forward to reading more from you, Jeff.

Because we don't know when energy will rally, consider some of the Canadian energy income trusts I've covered in my recent articles here on SA. Prices will appreciate along with energy, meanwhile you can get monthly dividends of 9% and more while you wait for prices to rise. You also get an added bonus of a USD hedge from the distributions being in CAD (automatically converted to USD by US brokerages). As currencies go, the CAD is a good long term USD hedge, for reasons I cover in parts 7-10 of my current series on "The High Dividend Investor's Collapsing Dollar Survival Guide."

Again, keep up the good work, Cliff

Apr 23 10:14 AM

[mbkelly75:]

I agree with Cliff in a couple of ways 1) It IS a good article. and 2) His series "The High Dividend Investor's Collapsing Dollar Survival Guide" is outstanding reading that I would recommend to anyone.

I believe that the price of both NatGas and Oil will go up later on in the year, but it does not matter if I am right or wrong right now. I have invested in dividend-paying producers while the prices are low and the stocks are WAY down. I am re-investing the dividends as they come in back into the stocks that paid them and doing fine while I am waiting. It does not matter if I hit the exact lows - if it goes lower - I will lower my cost-basis on the stocks by buying more when they are lower and continue to collect the dividends.

Apr 23 02:42 PM

[Eric Fox:]

"Chesapeake Energy Corp. (CHK) announced plans to cut natural gas production further..."

Has anyone seen any other announcements about cuts in natural gas production from others besides CHK?

Apr 23 05:36 PM

[rangerbill:]

The two win win Energy buys for long term and dividend would be HGT trust and XTO Natural Gas and Oil exploration.

Apr 23 05:57 PM

[mr clark:]

isnt nat gas already super cheap when u factor in monetary inflation and especially the increased risk to dollar value from the ongoing US financial/economic bailout???

Apr 23 08:18 PM

[optionsgirl:]

Yes, Devon Energy. Here is a quote from a month ago:

"The big bonanza is over,” said Jay Ewing, the completion and construction manager for Devon Energy in the Barnett Shale field here, where so far this year his company has brought its rig count from 35 to 8. “Everyone is really shocked how fast everything has turned".

----------------------...
Personally I think Canada's Encana (ECA) is interesting, here:
EnCana 1Q profit surges on low costs, hedging gain
EnCana 1st-quarter profit skyrockets on scaled-back costs, hedging gain

The Associated Press
On Wednesday April 22, 2009, 10:46 am EDT
Buzz up! Print
Related: EnCana Corp.
Canada's top oil and gas producer EnCana Corp. on Wednesday said its first-quarter profit surged as operating costs sharply fell and the company benefited from an inventory hedging gain.

Related Quotes
Symbol Price Change
ECA 45.71 +1.47

Quarterly earnings jumped to $962 million, or $1.28 per share, from 93 million, or 12 cents per share, during the same period last year.

EnCana's profit surge was bolstered by a nonrecurring $89 million hedging gain, compared with a hedging-related loss of $737 million in the first quarter of 2008.

The company also said operating and administrative costs for the quarter decreased about 31 percent compared with the same period last year due to a weaker Canadian dollar, lower fuel prices and lower long-term incentive costs.

"Substantially reduced field activity across North America is starting to result in lower supply and services pricing and, by the end of 2009, we anticipate price reductions could reach more than 20 percent from 2008 average costs, if current trends continue," said EnCana's chief executive, Randy Eresman.

Revenue slid 15 percent to $4.61 billion, down from $5.43 billion in the prior-year period. Cash flow for the quarter fell 18 percent to $1.9 billion compared to the first quarter of 2008.

EnCana shares rose $1, or 2.3 percent, to $43.94 in Wednesday morning trading.







On Apr 23 05:36 PM Eric Fox wrote:

> "Chesapeake Energy Corp. (seekingalpha.com/symbo...) announced
> plans to cut natural gas production further..."
>
> Has anyone seen any other announcements about cuts in natural gas
> production from others besides CHK?

Apr 24 12:22 AM

[Eric Fox:]

I was referring to companies that are shutting in production not cutting drilling. The point I was trying to make was that CHK alone can't balance the market through its shut in of gas production. This was point one the author made.

Apr 24 07:35 AM

[Buck East:]

Mclendon is wrong, and just schilling. Even if gas prices settled around the marginal cost of production because of shale, LNG is going to arrive in massive quantities and put NG prices into the basement for a long time. NG, like all asset classes, is deflating to pre-bubble 1998 levels--NG is just getting there first because of over supply. a full report at: www.thebarricadeblog.c...

Apr 25 04:37 PM

[jj Roberts:]

Aubrey McClendon would have CHK trading @ $100.00 per share right now if he had his wishes(shown by his failed leveraged margin purchases of his company-he lost almost a billion). You want to follow his call? That's laughable! NG production has been being cut off since the beginning of the decline, when it past $9 and continued falling. They can't stop the collapse. If speculators keep gambling on commodities they will always add an artificial 20%+ to the price(maybe more). I lived in the center of one of the largest inland hotbeds of NG exploration in the U.S., the Uinta Basin area, for 14yrs. When I came it was slow on drilling. The last 4 Years it was on steroids! Now it has COLLAPSED!!! quickly returning to activity of a decade ago. Until we have a meaningful switch to power automobiles by NG the long term high price outlook is much longer than a year(Don't count on that with Obamanomics). With debt/leverage destruction happening with rapid acuity, don't look for high prices to gain much ground. What the FED and Government are doing will probably take 2 years to get going. They have been way too slow, because their assumption has been it is not as bad as it really is in the contraction of the economy(IT'S DEEP!!!) Get ready for oil sometime to break it's lows and head into the twenties first(unless Israel bombs Iran-then we will see possibly $100 plus).

Apr 26 12:24 AM

[H.J. Huneycutt:]

I'm leaning the opposite way on this. I'd rather buy into oil than natural gas. Oil is a sure thing. Natural gas is not.

While the author does present some compelling arguments, the bigger picture is that oil is becoming increasing difficult to extract, which means prices have to rise over the long-term.

Natural gas, on the other hand, is becoming increasingly easier to extract, which means that prices can stay fairly "low" over the long-term. I'm not saying that NG prices won't come up from the current level --- but I don't know that they are returning to $7.50 - 9.50 per thousand cubic feet any time soon.

The oil/NG ratio is fairly meaningless if the underlying fundamentals are changing. The silver/gold ratio radically changed at one point several centuries ago because silver became easier to extract, so everyone relying on the ratio at that time would've been burned.

Also, while Chesapeake's CEO may be "bullish" on natural gas prices, insiders have been dumping CHK's stock over the past few months. That's hardly an affirmation of the great optimism at CHK.

I'm keeping away from the natural gas producers and I'm keeping away from buying natural gas. I don't think some of the companies associated with development are necessarily bad bets --- I'm long on Dawson Geophysical (DWSN), myself --- but I'm relunctant to go long on the producers. That said, if I had to go long, I'd probably pick a company like Atlas Energy (ATN) as opposed to Chesapeake (CHK).

May 01 07:07 AM

[Geoffrey Ching:]

H.J. Huneycutt,

You are right. If the underlying fundamentals change a lot, then the Oil / Natural Gas ratio would probably not be very useful.

May 01 07:59 PM