How Low Can Natural Gas Prices Go?

Oversupply

Recent reductions in natural gas (NG) price may be related to continued strength in production capacity, specifically in unconventional shale gas fields. The Potential Gas Committee estimated U.S. reserves are 35% higher than just two years ago, thanks to new technology that has allowed producers to drill for gas in shale rock. The committee estimated the country's total natural gas resources at 2,074 trillion cubic feet, an increase of 542 trillion cubic from its last report.

According to Ziff Energy, in 2008 shale gas production was over 5 bcf per day (8% of North American gas production), with 70% attributable to Barnett shale gas in Texas. Increasing unconventional gas production will comprise 53% of gas supply by 2020.

Sharp Contango Further Dampen Spot Prices

A significant differential between current spot prices and prices for NYMEX futures contracts for next winter delivery provides a strong economic incentive for the high level of storage activity. Traders on the futures market are able to lock in this difference of over $2 per MMBtu and cover their risk exposure by storing supplies until next winter, according to the weekly natural gas report by EIA.

In the short term, NG's price is still facing downward pressures from an excessive buildup in inventories. Prices could drop further if inventories keep rising until NG inventory nears storage capacity limits.

Will It Turn Around This Winter?

I compiled the average monthly NG price from the last 15 years' data. Not surprisingly, the highest price was in December, which was 20% higher than the lowest month (August).

However, supplies continued to be viewed as more than adequate to address near-term demand, including heating-related demand increases this winter.

How Low Could NG Go?

Energy Bulletin believes that shale gas is economic at the $5-6/mcf range. A Ziff Energy study found that overall full cycle costs for shale gas varied from $4.50 per mcf to 9.75 per mcf.

However, the variable cost is very low. For example, Southwestern Energy Co.'s (SWN) operating costs come in around $2.

In the short term, the price of natural gas could go as low as its variable cost. In the long run, it could only be sustainable at around $5-6 level.

Top 10 NG ETFs (by net assets)

#	Fund Name	Ticker
1	United States Natural Gas	UNG
2	Ultra Oil & Gas ProShares	DIG
3	UltraShort Oil & Gas ProShares	DUG
4	SPDR S&P Oil & Gas Exploration & Prod	XOP
5	IShares Dow Jones US Oil & Gas Ex Index	IEO
6	SPDR S&P Oil & Gas Equipment & Services	XES
7	PowerShares Dynamic Oil & Gas Services	PXJ
8	iPath DJ AIG Natural Gas TR Sub-Idx ETN	GAZ
9	First Trust ISE-Revere Natural Gas	FCG
10	Short Oil & Gas ProShares	DDG

Source: Yahoo Finance

Top NG Producers

If you like individual companies, instead of ETFs, the following are top NG producers:

#	Company Name	Ticker
1	BP plc	BP
2	Chevron Corporation	CVX
3	CONOCOPHILLIPS	COP
4	Exxon Mobil	XOM
5	Devon Energy Corporation	DVN
6	Chesapeake Energy Corporation	CHK
7	Anadarko Petroleum Corp.	APC
8	EnCana Corp.	ECA

Source: Wikinvest

Disclosure: I have a long position on UNG.

Comments

[learnmoney:]

At least you are honest about your long position in UNG. I have one too and soon we will make a very healthy return........

Aug 27 08:48 AM

[Steve20423:]

I have a long position in UNG. how do you figure we make a profit soon If there is no demand large enough to offset inventory and enhanced production capability? It appears the price will remain low for some time unitl demand picks to offset supply. that could be years

Did I miss something?


On Aug 27 08:48 AM learnmoney wrote:

> At least you are honest about your long position in UNG. I have one
> too and soon we will make a very healthy return........

Aug 27 09:31 AM

[Andiroo:]

What do people think about EP or CHK as a better play on a boost in NG prices than UNG?

Aug 27 10:20 AM

[JDP:]

What do yall think about paying for that contango every time UNG does it's roll?

Aug 27 10:26 AM

[Steve in TN:]

As JDP mentioned above, UNG will not capture most of the expected percentage increase in NG prices.

Aug 27 10:46 AM

[Jim Ellis:]

Question on the UNG etf: Is there a lot more risk that you could have destruction in the NAV even as the price of nat gas improves because the market is in contango and they are simply rolling over futures contracts?

Aug 27 11:09 AM

[Ferdinand E...:]

Very useful article. Very suggestive. Thanks

Aug 27 11:48 AM

[ACEMAN:]

Y'all are asking the wrong question, hence y'all can't make no money if yall asking this question. The real question as it always pertains to gas as well as oil is: how much is in reserve at below current CAPEX to sell at a reasonable or even leverage profit. Y'all take everything so literally that y'all don't understand how oil & gas is traded in the open and spot markets. Remember, there are contracts, agreements for delivery, there is deception, misleading numbers and prices, and lots of surprises to get y'alls money to buy at the wrong time. Y'all got to study oil & gas 101 and dedicate y'alls self to these great commodities and make your moolah in good as well as bad markets. You don't even have to short them. Keep your eye on reserves for a start. Now it's time to savor that beignet with your coffee.

Aug 27 12:03 PM

[climbera5:]

How does one determine what is a reasonable reserve level below current CAPEX? How do we find this out? At what point do you buy or sell? WIthout these details your comment is just a tease and smacks of arrogance.


On Aug 27 12:03 PM ACEMAN wrote:

> Y'all are asking the wrong question, hence y'all can't make no money
> if yall asking this question. The real question as it always pertains
> to gas as well as oil is: how much is in reserve at below current
> CAPEX to sell at a reasonable or even leverage profit. Y'all take
> everything so literally that y'all don't understand how oil &
> gas is traded in the open and spot markets. Remember, there are contracts,
> agreements for delivery, there is deception, misleading numbers and
> prices, and lots of surprises to get y'alls money to buy at the wrong
> time. Y'all got to study oil & gas 101 and dedicate y'alls self
> to these great commodities and make your moolah in good as well as
> bad markets. You don't even have to short them. Keep your eye on
> reserves for a start. Now it's time to savor that beignet with your
> coffee.

Aug 27 06:00 PM

[Road Runner:]

Yes ACEMAN. Teach us something instead of just snearing down your nose at us.

Aug 27 06:37 PM

[dieuwer:]

Producers have hedged at $7. They will get $7/mcf no matter what. Producers don't care what the spot price of NG is. They will supply NG until storage is full. After that, NG will be dumped on the street for $7.

The most important question is: who has taken the opposite trade of the NG hedge? Who is loosing money each day being forced to buy NG at $7 (and sell for $3)?

Aug 27 06:39 PM

[Road Runner:]

dieuwer, How long do these $7 contracts last? In other words, when will they have to be renegotiated at a lower rate, if the spot rate is lower then? If the rate is lower when it comes time to renegotiate and the spot price is below $5, do the producers just walk away and stop producing new wells?

Aug 27 06:49 PM

[naturallight:]

The marginal mcf of production is certainly not hedged.


On Aug 27 06:39 PM dieuwer wrote:

> Producers have hedged at $7. They will get $7/mcf no matter what.
> Producers don't care what the spot price of NG is. They will supply
> NG until storage is full. After that, NG will be dumped on the street
> for $7.
>
> The most important question is: who has taken the opposite trade
> of the NG hedge? Who is loosing money each day being forced to buy
> NG at $7 (and sell for $3)?

Aug 27 08:15 PM

[Domino412:]

Playing the drilling and exploration companies is risky. If nat gas does not rebound, and with mild winters and low demand, it looks like it won't. Companies like CHK are saddled with high debt. The lower nat goes goes and stays, the more likely these companies will go bankrupt. They simply can't operate with these low prices.


On Aug 27 10:20 AM Andiroo wrote:

> What do people think about EP or CHK as a better play on a boost
> in NG prices than UNG?

Sep 04 09:51 AM