Natural Gas: Long-Term Bull, Short-Term Bear (Part 1)

| About: The United (UNG)


This article was in final form and ready for publication 6/4/2009 but technical issues prevented that. Since then, as one would expect, some things have changed and I have also learned more and been "clued in" to some useful information and resources by others. I have tried to bring some items up-to-date, but of necessity and by accident there will be some older/inaccurate items that need updating. I invite your contributions to that in your constructive comments.

Why does a really new investor/trader like me attempt this article? Given the expertise I've seen displayed here, if I was not secure I would be fearful of excessive criticism and damage to my ego. Fortunately, that is not me. I decided to attempt this because I had recently considered investing in natural gas, via UNG and saw constantly conflicting recommendations, both strong and weak on both sides. Further, it occurred to me that as other newer investors, such as myself, were subjected to these conflicts, we might make inappropriate investments, be afraid to make any move at all, suffer great losses or have our capital inappropriately deployed for much longer than need be the case.

Being very altrustic in basic nature and believing strongly in all benefiting if all share, I wanted to contribute as well as benefit from the SA denizens.

Further, being able to find a single-source attempt at a comprehensive evaluation to use in making a decision seemed a fruitless endeavor. I was certainly not going to rely upon the shills that commonly appear in all the media, nor on the "sell-side" brokers that probably have large chunks of securities to unload on the unsuspecting, unwary and unsophisticated retail investor like me.

So with ego well in hand, I proceed.


What I present should be enough to cause bulls a bad case of indigestion, contributing substantially to global warming via the methane emitted from bovines. The EPA had proposed that commerce (or maybe it was the other way around?) should impose a carbon tax on cattle a few months back - that's your nonsensical government at work.

Other than BEAN-O, I have some thoughts to help avoid the affliction (and possible tax expense).

Due to a predominately negative assessment on all pertinent factors that I could identify, I am extremely bearish on natural gas near-term and recommend that all avoid it. For the long-term I am bullish and will post a follow-up for that case when time permits.

Furthermore, after a long and somewhat tortuous consideration of UNG as an investment proxy for natural gas, I adamantly state that it is only a short-term trading vehicle! As it is currently structured you can profit only if UNG makes a sustained rapid rise that exceeds the equivalent performance of the underlying futures.

Below are all the things I've been able to ascertain. Constructive criticisms are welcome, as are bits of information that fill in gaps in my knowledge. Items I've considered include:

  1. Oil vs. Natural Gas Price Linkage
  2. Economic and Policy Environment
  3. The Dollar vs. Oil and Natural Gas
  4. Oil-specific Considerations since that affects natural gas price
  5. Natural Gas Specific Items
  6. UNG-specific items

1. Oil vs. Natural Gas

I've seen and heard many comments stating that natural gas is set to rise because of the traditional ratio of price for oil and natural gas. This "old" ratio (whichever one that is) is broken and not likely to be seen again for eons!

The traditional ratio (if there ever was such a thing) of NG/oil price has disintegrated. Depending on who, what and when you read, the ratios have varied from as low as 6:1 to 18:1.

View this next chart with an appropriate amount of horror. One would be inclined to conclude that NG must rise so that the ratio comes back to some normalcy. I suggest that, for reasons you'll see below, this is the "new normal", at least for the near-term. References I touch upon below suggest that oil might regress, bringing this ratio closer to one of the historical norms.

WTIC versus NG Price Ratio Weekly View 6/18/2009

As recently as April of 2009, the ratio seemed near 12.5:1, as shown on this chart. Even then, this was higher than normal, as shown by A CXO Advisory Group July 28, 2008 article on oil and natural gas price relationship.

For recent general status of oil and natural gas, take a look at 6/17 This Week In Petroleum report.

Woolyboogur's comment in Scott's Investments Article "Time to Go Long Natural Gas and Short Oil?" provides some useful information about energy content vs. price of oil and NG: "On a Btu basis with gas at $4.00 you get about a million Btu whereas with oil at $72.00 per Bbl you pay $12.4 per million Btu". Without radical transformations in the supply/demand relationships, infrastructure, portability issues and other such factors, the price ratio of oil to gas can be expected to experience both volatility and to maintain a very high ratio. See the chart above for how it looks currently.

Since it seems that oil prices are (temporarily, in my opinion) artificially high and NG price is now held low by a severe over-supply/under-demand (my opinion) situation, if the price ratio is to come anywhere near historical levels, oil must come down because natural gas cannot go up. See the oil-specific discussion below.

Another possible down-side "catalyst" seems embedded in CNBC guest, President of Cameron Hanover, Peter Beutel's comments on oil and gas.

He is predicting oil will eventually (late this year, early next?) return to a $40 or so level and feels NG is a better investment. He stated that the normal ratio, this century, is 8.5:1 (in the video, but not in the text on the web site) and says the ratio has been out of whack for some time and is expecting a return to that normal.

In summary, the traditional price-ratio of oil to natural gas is broken and any adjustment to lower ratios, considering supply levels (see below), seems most likely to come from a regression in the price of oil.

Economy and Policy

All the big banks, and several less-than-big banks have paid back, or are preparing to pay back, the TARP, for reasons we need not discuss here. This is capital they will not have available to lend to help stimulate the economy, which they were not doing anyway. The TARP funds and capital raises they have done were/are purely to bolster their balance sheets and we can presume that we'll see the same results, except that now they can pay themselves and spend on promotion, junkets, etc., as they please without interference from the government (until the new super-regulations, as proposed in an 88 page framework document of 6/17/2009 by BOH and to be, as usual, modified by our Congress, take effect).

A concern of which I recently became aware is the action in the treasury bonds. From the chatter on the tube, rising treasury yields imply more than just inflation. It seems that it also indicates a fear of increased risk of default, weakening or aborted recovery in the economy, etc. Why? Well one reason is that there is a direct effect on mortgage rates. While the Fed is trying to force rates down, the rates were rising, although they have eased recently. Will that hold or will they start up again?. Anyway, this implies an inability of the Fed to cause further beneficial effects with the current tools. The bond vigilantes seem to have good control. With Fed Fund rates already at 0-0.25%, QE pretty much done (although the money is just sitting on the banks' balance sheet, improving their capitalization), what else can the Fed do to kick-start housing, considered an important of the recovery effort? I suspect that only legislative and fiscal policy can have further beneficial (if one considers getting consumers to increase debt at a time like this) effect.

This then has the effect of keeping the economy from recovering as quickly as anticipated, the market from breaking higher, implies continued commodity deflation, etc. So NG and UNG may be under even more pressure than that provided by an oversupply situation as consumers continue to pull back, with increased savings, reduced energy usage (see the sections below) and reduced spending generally hitting commercial entities as well. It means that any near/intermediate outlook for (rising) demand may be overly optimistic and insufficient to compensate for the anticipated reduction in supply as more NG shut-ins occur.

Consider the general conditions we've seen that should affect our long-term decision-making process.

The economy is still weak(ening?) as indicated by same-store sales results reported on June 4. Don't be fooled by the small recent increase in the construction spending and other leading indicators. All the pundits (I include economists in this camp - they agree with each other about as often as the other pundits do) agree that the consumer is key to the economic turn-around. And guess what! The reported savings rate has now increased to 6.4%. The consumer is not spending. With new jobless claims of 630+K on 6/4 (6/18: 608K new claims, plus 3K, and continuing claims at 633.75K down 7K), who can blame them? The economy is not on a fast-track to recovery.

The "stimulus plan" (cough, cough) still has months to go before it has what little effect may be expected, according to TraderRob in "Stimulus Effects Not Yet Seen in Economic Data".

Under these conditions, summer A/C thermostats will be set up and winter settings will be down. This reduces electricity demand and that means that utilities will not need as much NG for their peak-demand generation activities and home heating draw will be lessened. If the summer and winter are mild, the effects will be exacerbated.

In support of the "brown weeds" corollary of the "green shoots" theorem, these posts "Mortgage Delinquencies as a Percentage of Loans" by Richard Shaw, "The Proof That There Are No 'Green Shoots'" by Karl Denninger and "Green Shoots Are Parched" by Tom Lindmark all support an assertion that recovery will be slower than what many expect, thereby keeping NG prices suppressed for a long, long time.

The tidbit of note from Richard Shaw's piece was "Prime loan delinquencies rose to 6.06% from 5.06% one quarter ago, a significant and disturbing increase from a group of borrowers that aren’t expected to default".

This is the first statistical support of an assertion I saw previously that defaults had spread to prime borrowers. This implies that, indeed, we have not begun a real recovery. By inference, certain consumer-driven actions that would increase NG demand are forestalled even more.

Karl Denninger's piece was a presentation of the math that demonstrates that the Fed's ZIR/QE policies have failed to hold mortgage rates down and that this, when combined with ARM resets, eliminates the possibility of recovery in the commonly projected time-frames.

Tom Lindmark's piece drew on the "Beige Book" to support his thesis. But check the comments from Thiazole in that article. He posts URLs that he says support "shoots", not "weeds". I've not looked for myself yet as this is supposed to be my bearish near-term argument.

I've heard the administration repeatedly mention "coal gasification" or "coal liquification" as one of the main platforms in the "green portfolio" and, as I recall, seldom mentions NG. I won't speculate here on why.

We need to check the status of the legislation referenced by Michael Fitzsimmons - H.R. 1835: Legislation for Natural Gas Transportation. It's an April 5, 2009 article. I'm hopeful that it, or its replacement, will be more pro-natural gas. But until I can check on it, I don't use it here for an argument.

Dollar vs. Oil and Natural Gas

The dollar entered a short-term nose-dive pattern and oil and other commodities began to take off. Then the dollar recovered and oil's rise moderated and reversed. Natural gas did get a temporary bump, but nothing major. Here's a summary, from, of what has happened with the dollar and oil since that time to now, 13:35 on 6/18/2009. The next chart is the dollar and natural gas.

One thing to note on the natural gas chart is that there is a suspected manipulation that takes advantage of some UNG shortcomings. That is addressed further in the section on UNG. Regardless, keep in mind that NG futures expire 6/26 and roll-forwards could be occurring and account for near-time rise.

You might be able to verify this in the expiration dates table provided in the UNG section.

U.S. Dollar vs. Oil 2009/6/18 Overlay Chart,

U.S. Dollar vs. Natural Gass 2009/6/18 13:41

An important thing to note in the above two charts is how the oil price consistently responded to the dollar index movements, whereas natural gas did not. What this tells me is that near-term the oil price is more likely to drop, since the dollar seems to be maintaining its strength, while natural gas price seems more-or-less random.

My conclusion is that the movement of neither the dollar nor oil provide a near-term catalyst for the price of natural gas. With such a severe over-supply condition, this is not surprising.

Part 2 >>

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