Opportunities for Both Shorts and Longs in Natural Gas

In early September, I voiced my concerns on natural gas over-supply in Commodity Trading Strategies: Profiting from Gold and Natural Gas. As things would have it, the price of natural gas staged a scathing rally gaining over 35% through mid September.

Today’s inventory report brought back concerns of an oversupplied market. The U. S. Energy Department’s Energy Information Administration reported that natural gas stored in the lower 48 states amounted to 3.589 trillion cubic feet, an all-time seasonally adjusted high. Natural gas inventories are 491 billion cubic feet higher than they were a year-ago and 481 billion cubic feet above their five-year average. Inventories are in fact pressing against EIA’s estimated peak storage capacity of 3.9 trillion cubic feet.

The spot market reacted quickly and decisively in response to this inventory data and the spot price of natural gas fell sharply. Futures prices of natural gas have been somewhat more resilient. Hopes of a cold winter and a recovering economy have helped contain the damage here. Natural gas for November delivery trades at a nearly 60% premium to the October spot price.

Despite concerns on the strength of the economic recovery, most indicators suggest that the worst is over. The Institute for Supply Management's manufacturing index has exceeded the 50 threshold for the second straight month in September. The Commerce and Labor departments have reported an increase in August consumer and construction spending.

Today’s pullback in natural gas is giving long-term investors one more opportunity to get in fairly close to the rock. Shares of Anadarko Petroleum (APC), Chesapeake Energy (CHK), Devon Energy (DVN) and Canada-based EnCana (ECA) offer ways for the longs to profit from an eventual turn in natural gas. Or, one can get into the commodity through iPath DJ AIG Natural Gas ETN (GAZ).

As for traders, the short side looks more appealing given the massive natural gas inventory overhang.

Disclosure: I do not have long or short positions in any of the securities discussed.

Comments

[meridian575:]

There should be a huge industrial demand for naturla gas as the Obama adminstration's DOE Clean Citites Program takes affect. It already has 300 million to spend on natural gas projects for the roadways. Yahoo Finance has the jump:
finance.yahoo.com/news...

Oct 02 10:55 AM

[Aricool:]

Great article! Time to buy Nat Gas. Here are some reasons why:

i) The economy is picking up: Demand is showing signs of life and the manufacturing sector is demonstrating its first signs of growth. One can expect gas demands from gas-fired power plants to rise accordingly.

ii) The oil to gas price ratio: Eventually, I do believe that the relation between the price of oil and gas will resurrect. The recent spike in the oil to gas price ratio to 25x will likely return back to normal in the long run. With the economy picking up and oil futures pointing upwards, one can expect that the gap in this ratio will close.

iii) The weather: We are heading into Q4 which means that winter is approaching! Gas demand typically picks up in the winter months and gas prices historically have done well during this time of the year. Further, a very cold winter is forecasted, allowing inventories to come way down.

iv) Environmental policy: The Obama administration is pushing ahead with climate change initiatives that will cut green house gas emissions over the coming decades. Although the plan is not centered on gas-fired energy production at the moment, there is almost no feasible alternative to the power plan that would allow the U.S. to reach its targets in its given timeframes. Most of the power in the U.S. is generated from coal-powered power plants which are a key contributor to the green house gas problem. Getting off of coal and onto emission friendlier power substitutes like wind, solar, and nuclear is a long term project which will likely require a mid-term solution. Gas-fired plants do produce green house gases but much less than their coal-fired counterparts - it would be much quicker and cheaper to substitute coal-fired plants for gas powered ones. This would allow for an interim step in achieving the green house gas emissions reduction time frames.

v) Demand from Emerging Economies: It's a known fact that India and China are consuming more oil, but they are also consuming more natural gas. With gas liquefying techniques improving, the transportation of natural gas across our oceans, as is done with oil, is likely to become more feasible in the future. More accessible gas transportation = more demand from emerging economies = increased prices.

vi) With new CFTC position limits and the fact UNG is not able to sell many new shares so it will not be able to significantly affect the nat gas futures.

Nat Gas is too cheap. The Natural Gas futures bull run always stays strong in October!!! Buy buy buy...

Cheers,
Ari-

Oct 02 03:19 PM

[ETETET:]

I think it's better to go long on short squeeze than shorting NG during short-term oversupplies.

Oct 02 05:22 PM

[gold48:]

although i share your longer term bullishness, we do still have a temporary supply glut and storage deficiency. There actually is no where to store the nat gas which is being produced. Until this is worked off, hopefully with a very cold winter, sustained rallies are going to be difficult. Your comment about the oil/gas ratio is very CNBCish, it is not relevant. Oil is a global commodity and NatGas is very regional and they are not interchangeable in their uses. NatGas is primarily an industrial heating commodity and competes with coal more that oil. It makes for interesting charts, but is very misleading to uneducated investors. One of the better ways to invest in natgas and to avoid the costly contango in the futures contracts is via Hugoton Trust (HGT) which is a royalty trust that pays its dividends two months in arrears based on the then price of nat gas. They do not hedge (like most of the producers mentioned) so you have a pure play in the increase in spot nat gas

Oct 03 10:49 AM

[Gigem77:]

Ari is wrong on several points. Natgas is not fungible like oil. US export capacity is quite small and other sources exist closer to Asia. So demand in India has no impact on US natgas prices or supplies.

US consumption is still running about 4bcf per day less than during the same period last year. Industrial demand is responsible for this drop. The mounting job losses tell us that demand is not returning. The inventory replacement bounce in GDP is temporary.

The UNG is issuing more shares. They began on September 28th.

Pressure in the pipelines and storage facilities is so high that operational flow orders have been and are being issued to stop the producers from compressing more gas into the system. The rig count is increasing from the summer lows. There are hundreds of wells that have been drilled but await completion. So the supply overhang is not just from storage, but also from curtailed production. This means that winter draws will be smaller. We will exit winter with more gas in storage than last year and begin this cycle again. When will industrial demand rebound?

Residential and Commercial heating demand during the winter are not enough to compensate for the loss of industrial demand. We need petrochemical plants, car factories and refineries to reopen or increase capacity utilization and that is not happening yet.

Nothing the politicians have done so far is helping natgas. If they would convert the government's fleets of vehicles to use CNG, that would help. Heating oil prices are low and inventories are above the high end of the average range. All of this is good news for consumers this winter.

So the best hope for the natgas bulls is that speculators will run the price higher and that there will be sharp short covering rallies like the ones seen this year. That is a trading environment for the nimble. It is not time yet, imo, for longer term investors to put money to work here.

Shares of producers like UPL, XTO and CHK are tracking the broad market, not the natgas price. So they are quite overbought and will fall with the SPX when it corrects. Their 7-9 dollar hedges are dropping off the books. So earnings will show some real hits over the next few quarters.

Oct 04 10:20 AM

[Genesis:]

Have you looked at a chart of natural gas chart lately? I think much more can be squeezed out of the shorts.


On Oct 02 05:22 PM ETETET wrote:

> I think it's better to go long on short squeeze than shorting NG
> during short-term oversupplies.

Oct 04 02:07 PM