Natural Gas: Prices Remain Firm Despite Bearish News

Natural gas prices stayed remarkably strong this week, despite two very bearish developments. This is actually bullish, when a market won’t go down on bad news. Yet I still think this downturn in natural gas prices could be longer than people think. I am not buying natural gas stocks right now.

The bearish points this week were:

• 1) An injection into storage this week of 114 bcf, the fourth week in a row of 100 bcf + injections. (I don’t think this has ever happened before.) Expectations were for 105 bcf, and almost double last year’s injection for the same week.
• 2) The rig counts in North America turned slightly higher this week, for the first time in 2009. In the regular Friday report from Baker Hughes, US gas rigs were up 6 over last week, and horizontal rigs were up 20 - which deliver a lot more gas than verticals. Canadian rigs had a much bigger percentage jump, up 35 to 143. About 66% of all rigs in Canada drill for gas (though this number is surely going lower). Of course, these numbers all half of what they were a year ago.

Despite this, natural gas prices for the July NYMEX contract stayed above $4, closing at $4.09. Henry Hub prices were up 4.5% this week. Canadian AECO hub prices closed at $3.47.

It’s clear that investors remain focused on the expected supply drop in natural gas being severe, and causing a rapid ascent in natural gas prices later this summer. And sentiment is increasing that prices must rise to the $8/mcf range to turn a profit on “full cycle” costs (not just operating costs, but finding costs and land acquisition costs etc.)

(I don’t know how much of that “full cycle” argument to believe. Most of those high costs on the new, very productive tight and shale gas plays come from the high prices companies paid for the land, before the crash. Costs had skyrocketed. And those are now sunk costs. The reality is that the gas coming from those properties may never produce a “full cycle” return because of the cost structure in the industry at the time and the high land prices generated by mania surrounding shale / tight gas. As this gas glut persists, operating costs will continue downward, and once land prices do as well, I see full cycle costs going a lot lower - but not for a year or two.)

I think there are a couple points that could prolong this natural gas price downturn longer than people think:

1. Banks did not dramatically cut back on credit lines for the producers this year, despite a big drop in gas prices. So even though a natural gas producer was operating close to its debt limit, it wasn’t forced to make the tough choices to survive. This painful process of keeping alive a dying patient will now be drawn out longer than normal.

2. New junior companies cannot get financed. So when two or more companies merge, one management team is out of a job. And in this market, they won’t get a new one. So management has no incentive to sell or merge.

3. The banks are saying - I have two sick patients, each having 80% of their debt drawn, and they want to create one larger sick patient with 80% of its debt drawn….no thanks.

4. Most junior and perhaps even some intermediate companies are receiving very little cash flow right now and still have some fixed costs - like regular interests payments on their debt…even a little cash flow is better than none. So I think they will be hesitant to turn off the tap, no matter how the small the drip.

5. And again, LNG is a wild card. If Asian demand doesn’t pick up soon, the global fleet could be coming to North America and keeping prices here suppressed.

Most gas stocks and the energy sub-indexes in the US and Canada are rolling over to the negative now. After the good run up in natural gas stocks this spring, gas prices had to start showing some signs of recovery, or gas stocks would turn lower. It looks like they’re turning lower. Only the most favoured mid-tier producers like Storm (SEO-TSX) and Celtic Exploration (CLT-TSX) are still in consolidation patterns. (I own neither.)

I’ll be watching the natural gas market and my favourite gas stocks closely for a potential summer entry. None of my current portfolio purchases are gas weighted. Both the charts and the fundamentals tell me I should wait.

Comments

[prairiedog555:]

Don't forget the hurricane play. Most of the bad ones come in Aug-Sept. When they announce a coming storm buy the land producers like EOG. Seems to work every time.
But as they say "this time it's different" and "your mileage may vary"

Jun 22 08:56 AM

[Mad Hedge F...:]

But the risk has gone up. The Potential Gas Committee of the American Gas Association published a report that US reserves have jumped by 35% to 1,836 trillion cubic feet, thanks to the huge discoveries of new shale fields since 2006. Also contributing are the new fracturing technologies, which I had a hand in pioneering myself ten years ago. That means our natural gas reserves can now meet 100 years of current consumption, and are roughly equivalent to Saudi Arabia’s crude reserves on a BTU basis. Natural gas futures dove 26 cents to $4.23, and the ETF (UNG) gave back 4%. A buddy of mine close to the committee warned me that something like this was headed down the pike, which is why I sent readers a warning two weeks ago to cash out at $4.30 (see www.madhedgefundtrader...). When you only see chart driven traders buying a commodity and the industry insiders selling the Hell out of it, you want to stay away. Bewildered technicians were last seen feverishly searching for Hainesville on Google. It was their models that sucked $3 billion into UNG over the last three months. This is great news for the big consumers of NG, like the utility industry and the petrochemical industry. It will also give a shot in the arm to Boone Pickens’ plan to shift our transportation system to NG (see www.madhedgefundtrader...). Even the ratio, pairs, and mean reversion traders have been burned by NG this year. As cheap as NG is, a Saudi Arabia’s worth of supply hitting the market could easily knock the price down by half from here. As extreme as the move in the oil/gas ratio is at 18:1, we could be breaking new ground

Jun 22 10:08 AM

[H. T. Love:]

Both CSU and Accuweather's Joe Bastardi (Thanks Freya) predict a milder than normal hurricane season this year, although some "pop-up" storms could occur in some areas. If true, those opportunites might be sparse this year.

HardToLove


On Jun 22 08:56 AM prairiedog555 wrote:

> Don't forget the hurricane play. Most of the bad ones come in Aug-Sept.
> When they announce a coming storm buy the land producers like EOG.
> Seems to work every time.
> But as they say "this time it's different" and "your mileage may
> vary"

Jun 22 12:24 PM

[Shale Gas:]

Here's something to consider on the supply side. Natural gas production has not fallen yet despite the lower rig count because the number of horizontal wells has increased relative to total wells drilled. These horizontal wells are as much as four times as productive as vertical wells.

Jun 23 07:07 AM

[Rice_Rocket...:]

Shale Gas,

We are seeing some supply response. You will not see it in the EIA monthly report since it is on a 2 month delay, but my model is lower my about 2 bcf/d since the high of 58 in Feb (dry prod.)

Also, horizontal rigs are lower by 153 y/y as of last Fri. What do you mean by increased?


On Jun 23 07:07 AM Shale Gas wrote:

> Here's something to consider on the supply side. Natural gas production
> has not fallen yet despite the lower rig count because the number
> of horizontal wells has increased relative to total wells drilled.
> These horizontal wells are as much as four times as productive as
> vertical wells.

Jun 23 09:56 PM

[Shale Gas:]

I meant the number of horizontal wells as a percent of all wells drilled. I don't have the numbers in front of me but something like 20% of all wells drilled in NA are now horizontals. Five years ago it was maybe 5%. Horizontal wells are much more productive than verticals, so even though the rig count has dropped, supply may adjust slower than the market thinks given the productivity.

Jun 24 09:03 AM

[Rice_Rocket...:]

Yes you are right the weight of horizontal rigs increased significantly from 10% 5 yrs ago to 40% at the high in 8/19/08.

My thought is regardless of the rate of supply response they will keep shutting in rigs in order to rebalance supply-demand. If this must come to the point where horizontal rigs are 75% of total gas rigs so be it. As convoluted as this sounds the cure for low prices is LOWER prices. Prices must go lower to uninterrupt coal to gas substitution, disincentivize producers from turning rigs back on, and keep the LNG from flooding the U.S. markets.

In my coal to gas substitution model that number is 4.05. That should serve as the fundamental ceiling on ng prices.


On Jun 24 09:03 AM Shale Gas wrote:

> I meant the number of horizontal wells as a percent of all wells
> drilled. I don't have the numbers in front of me but something like
> 20% of all wells drilled in NA are now horizontals. Five years ago
> it was maybe 5%. Horizontal wells are much more productive than verticals,
> so even though the rig count has dropped, supply may adjust slower
> than the market thinks given the productivity.

Jun 25 04:30 PM

[Commies are...:]

Isn't the oversupply already well known and baked into the price? What are they going to do, give gas away for free? If yes, how are producers making money? Kickbacks from GS?

Aug 22 07:55 PM