Natural Gas CDS Equity Spreads: Volatile

Remember those halcyon days when “less bad” was, to quote that champion of a healthy breakfast Tony the Tiger, G-R-E-A-T! Now we have home prices rising two months in a row, durable goods orders rising close to 5% and a national ISM Manufacturing Index that not only moved into positive territory but beat expectations by 2.4 index points and the markets are unimpressed to put it mildly.

The market had been on a tear as of late although given the sharp move down in mid-August only to be followed by a move to new highs before the panic producing plunge yesterday, the thing that is most torn is the P/L of yours truly. The CDS market was taken on the inverse of the same roller coaster and that’s our indicator of choice so we’re sticking with it. Besides, nothing works all the time. Does it?

If the stock market needs an example of how to make its way lower, there is a product out there that has had a lot of practice moving in that direction this year and that would be natural gas. The CFTC has spent a lot of time trying to figure out if UNG, the ETF that represents a long position in the methanous mixture, is giving those dreaded “speculators” an unfair advantage. Given that an inert gas cannot go bankrupt, it is unlikely there will be rampant CDS buying on the futures contracts.

Recent finds and a lack of demand have moved Nat. Gas prices down by 30% since early August and the fear in the market is that there will be more gas than there is storage space. The good news here is that the Energy Information Administration is expected to announce additional storage capacity of approximately 100BN cubic feet soon.

I am not sure if that will help prices at all but that’s an awful lot of space and it makes it abundantly clear that someone should put some effort into figuring out how to use more of the stuff than we do.

There is hope and it is coming from the most unlikely of sources, Congress. Well, maybe not so surprising when you learn that it’s a variation on the “cash for clunkers” bill and will be using your tax dollars in the process.

The House of Representatives has a bill waiting for it when it returns from summer recess that would offer tax credits of up to $12,500 for the purchase of cars and trucks that run on natural gas. Included in the bill are additional credits of $64,000 if you run a fleet of vehicles and $100,000 if you open up a filling station.

Providing the economic impetus for a move towards natural gas makes some sense when you consider the energy independence, infrastructure building and green technology aspects of the proposal.

Chesapeake Energy (CHK), El Paso (EP) and Kinder Morgan Energy Partners (KMP) are the names responsible for finding more gas than we can use at the moment.

Companies like Wal-Mart (WMT) and PepsiCo (PEP) as well as all of the long haul shippers that frequent the 184 truck stops that dot the North American landscape all fall into the end-user category.

The CDS/equity relationship for CHK has been as volatile as the gas itself this year making sharp moves in a trading range that has $13.00 and $25.00 as bounds. The CDS has like wise moved primarily sideways between 850bps and 550bps.

Although the specific numbers are different, in general, the same can be said for both EP and KMP. It will take a clearer picture of when a true turn around in the economy begins as well as more information on how to use all of the gas we are pumping into storage before the CDS/equity trends in these names becomes clearer.

WMT’s CDS slid down a pretty smooth slope this year peaking at 111bps in March and bottoming on 8/7 at 33bps. Since then it’s been up for the CDS and down for the stock with the pair closing at 48bps and $50.97 respectively last night.

PEP has had a bit of a better time of it with its CDS topping out at 80bps this spring while the stock bottomed ($45.81) around the same time. Since then its been down for the CDS and up for the stock albeit in choppy fashion at times. PEP’s CDS closed at 40bps last night up from a recent low for the year of 32bps in early August. The stock closed last night at $57.29 after topping out at $59.06 during that same time early last month.

Comments

[Mad Hedge F...:]

hjk. “When do I buy natural gas” is the most frequent question I am getting from clients these days. I can’t blame them, after watching CH4 dive from $13.50/MCF last year to a September contract low of $2.72. Massive new discoveries and an unusually cool summer is causing a looming storage shortage that has hammered longs. Those who dove in early have been punished, with stop outs followed by stop outs. The bizarre thing is that gas went up in flames while crude more than doubled, from $32 to $77, leaving pros stunned and speechless. The crude/gas ratio has soared to an unimaginable 27 times, up from a mere four times in the last decade. On a BTU basis, gas is now only 25% the cost of oil, it burns cleaner, with only half the carbon dioxide output, and is cheaper than high grade coal. Natural gas at these prices is another way of buying oil at $18 a barrel, with less pollution. Industry insiders don’t see it falling below $2/MCF, the breakeven cost of the longest term producers, where the shut off valves will start creaking en masse. Existing gas fields deplete at 25% a year, and the 60% cut in new drilling this year will deliver a rebound in prices by next winter. Longer term, the Pickens plan and the conversion of a large part of our national power generation to natural gas will drive prices higher. In the end, I think the final low will be defined by another Amaranth type disaster, where a super leveraged long hedge fund gets wiped out and is then liquidated under the worst conditions imaginable. In 2007, the Amaranth debacle took gas from $17 to $4 in the blink of an eye. Where Amaranth 2.0 will take us is anyone’s guess. But when it happens, possibly as early as September, other big hedge funds will stampede in like feral cats lapping up spilled milk. If I lived over a giant salt cavern, I would be pumping it full of natural gas now. But since these formations don’t exist in Northern California, I shall have to content myself with the futures markets, where longer dated contracts are selling at big premiums. Email me at madhedgefundtrader@yah... if you need help getting set up on the futures. For those not looking for an “E” ticket ride, it may now be time to Hoover up the leveraged natural gas equity plays like Chesapeake (CHK), XTO Energy (XTO), Southwestern (SWN), and Petrohawk Energy (HK), which appear to have already bottomed.

Sep 02 10:24 AM

[Danny Devito:]

where do you trade the CDS? or just bloomberg quotes?

Sep 02 06:13 PM

[OneRichOne:]

When will the auto makers learn to build dual fuel vehicles? Its pretty simple and is done in Brazil. Natural gas is not the total answer because it can't produce enough horsepower to climb steep hills but with today's autos that are controlled by computers it would be a very simple thing to produce dual fuel cars that when the extra horsepower is needed, gasoline is used in conjunction with natural gas to produce the HP required.

Sep 02 06:42 PM

[User 481271:]

OneRichOne:
A crossover-SUV with gasturbine, capable of using all kinds of biofuel will roll out from Velozzi in Los Angeles before newyearseve 2012. It's called Solo. Thegreencarwebsite.

Sep 02 11:48 PM

[Aricool:]

OneRichOne,

How would this work with Desil engines in cargo trucks? My understanding is that the first roll out that is most cost effective is to supply NG stations on the two main east/west highways and convert trucks on those routes to NG. This is Picken's current proposal. However, if what you say is true, would that be a problem for such a plan?

Ariel-

On Sep 02 06:42 PM OneRichOne wrote:

> When will the auto makers learn to build dual fuel vehicles? Its
> pretty simple and is done in Brazil. Natural gas is not the total
> answer because it can't produce enough horsepower to climb steep
> hills but with today's autos that are controlled by computers it
> would be a very simple thing to produce dual fuel cars that when
> the extra horsepower is needed, gasoline is used in conjunction with
> natural gas to produce the HP required.

Sep 04 02:28 AM

[H. T. Love:]

"The good news here is that the Energy Information Administration is expected to announce additional storage capacity of approximately 100BN cubic feet soon."

If I recall correctly, that is a "design capacity". Generally the design capacity is much higher than working capacity, affected by various factors including pressure gradients required. The low I rember is 73%, which would mean an increase of 73Bcf. The high was about 97, again if I remember correctly. That would be 97 Bcf.

So, we gain about 1.5 weeks worth of net injection at best and 1.16 at worst.

I won't turn any handsprings over that.

HardToLove

Sep 04 04:24 PM

[kstock:]

Utility natural gas usage should increase as the U.S. public bus system is using more and more CNG powered buses due to government subsidies. Those CNG vehicles now account for 25% of sales. Yahoo Finance has an article about this:
finance.yahoo.com/news...

Sep 22 11:08 AM