Natural Gas: Ride U-Turn Up

Introduction

The writer, having always been interested in Natural Gas, was watching with amazement as the pricing of this commodity tumbled over the course of 2008 to 2009. See the following chart for the precipitous drop:

Click the chart for a larger view.

Figure 1: Natural Gas Pricing in Past 3 Years. Note the drop from the peak of $13.69 in July 2008. Also note the sharp price reversal that started in September 2009. Source: www.stockcharts.com.

In the above chart, notice the highs in Summer of 2008 of $13 for Natural Gas. The chart shows the New York Merchantile Exchange (NYMEX) spot pricing at the Henry Hub in Louisiana. Approximately 50% of the US consumption passes close by to this centralized distribution point, so the pricing here sets a standard price for trading markets. The Natural Gas spot price slid uninterrupted until March 2009, when I started watching. Then the price churned sideways in Spring and Summer of 2009. From my tediousness in watching the churning, the writer missed the start of the run up at the beginning of September 2009. This trend reversion appeared to be part of the Gold, metals and commodities bull push up that began this fall at the beginning of September.

Then recently, on November 18, 2009, the writer caught the article by Sol Palha describing how Natural Gas may make a good long term play and I decided to capitalized upon this trend.

Situation Analysis

New Sources of Supply

Natural gas pricing is burdened with the tales of new discoveries of Natural Gas in shale rock formations. The stories relate that supplies with this new technology of sideways drilling will supply vast amounts of the neglected energy fuel for decades into the future. Also, there are other unconventional sources that new technology is bringing to the forefront such as Deep Natural Gas, Tight Natural Gas, Coal Bed Methane, Methane Hydrates and Geopressurized Zones. For a primer on these new sources see this Natural Gas Organization link.

Analysts are divided about the cheap gas potentials. At the Peak Oil Conference in Denver on October 13th, 2009, Energy Analyst Randy Udall stated, “The U.S. gas production peaked 35 years ago, and the roughly 10 percent jump in production over the last four years required doubling the drilling rate.”

Whatever the case may be, the writer believes the markets have already priced in all the theories of Natural Gas boom or bust into the pricing.

Economic Support for Higher Pricing

Though there is still widespread concern about the robustness of the economic recovery and criticism about the recovery without jobs, the stock markets have clearly made a strong move up from March of 2009.

A leading indicator for the recovery is the pricing performance of the commodities upon which the economy is based. Examining the Continuous Commodities Index (CCI) gives one a good proxy for the leading edge of the economy’s behaviour as the index is composed of 19 raw materials used in industry. See the chart below for the calamitous drop of the CCI index in Summer of 2008 and the slow climb back this year.

Figure 2: The Commodities Research Bureau (CRB) Continuous Commodity Index (CCI) of 19 key commodities. Note the peak in July 2008, similar to Natural Gas (Natural Gas is 6% of this Index). Note that recovery for CCI started in December of 2008, while Natural Gas waited for Fall of 2009 to make any moves.

Comparing the Natural Gas NYMEX price chart to the above CCI chart, we see that the Commodities led the way, and that Natural Gas only started to move this Fall. This may stand to reason, as gas demand is cyclical annually and the demand season is just beginning to start with the onset of winter.

For further confirmation of the economy recovering, we examine the Baltic Dry Index. This is a shipping price index out of London, England which tracks the cost of international shipping of bulk cargoes. This is the follow up to the CCI as the cost of delivery of the commodities to the end users. The chart of the Baltic Dry Index below shows a bottom at the end of September 2009, with a sharp rise into October and November.

Figure 3: Baltic Dry Index of Shipping Costs. Note the bottom set at the end of September and the sharp rise into October and November.

From the commodities pricing behaviour and the rise in the Baltic Dry Index, the writer concludes that there are good supports for the idea that the recession has ended and that the recovery is on the way.

Annual Cycles for Domestic Natural Gas

Historically the gas prices are higher during the winter heating season as shown on the chart below.

Click the chart for a larger view

Figure 4: NYMEX Natural Gas Price - 12 previous months. Note the Winter and Summer Pricing Cycles. Source: www.oilnergy.com/1gnymex.htm#year

The US Natural Gas distribution authorities purchase and store the gas underground in the Summer months and withdraw the gas for usage in the Winter months. The date for stopping the injection storage and for starting withdrawals for sales is creeping up on us; the start date may be during the week of November 23rd, 2009, dependent upon the weather. This annual pricing cycle for the winter heating season just adds further confidence to the trend reversal.

Natural Gas Bottoming and Trend Reversal

From the chart displayed in Figure 1, the Natural Gas price bottom was hit on September 4th , 2009 at $2.62 and a sharp reversal happened. The price rocketed up to $5.83, reached on October 21st, 2009. Since then the price has eased off, settling just about the $4.50 range, presently.

This writer actively seeks value situations where a trend bottoms and a reversal is due. For Natural Gas, the bottom may have been reached in September and this November correction is merely a small pullback before a resumption in the up trend. This previous bottom, in the writer’s opinion, makes the risks smaller, as the bottom has already been placed for Natural Gas.

For a second opinion, here is an interview with Robert Cooper, Acumen Captital Finance Partner, captured by Arjun Rudra, another Seeking Alpha contributor titled, “Cooper, Turnaround Happening for Natural Gas”.

Playing the Trend

There are many ways to play this trend. The Natural Gas industry has been battered by the year long slide in the commodity price, and one can pick through the litter for value. The writer is partial to large pipeline companies such as Enbridge (ENB) and Kinder Morgan (KMP), though they encompass more than just natural gas.

For further background and understanding about Natural Gas, a good Triology about Natural Gas was written by Joseph L. Shaefer, another Seeking Alpha contributor, starting with “Natural Gas: America’s Energy Salvation”. For a discussion on the merits of some Natural Gas companies see “The Nine Best Natural Gas Oil Pipelines” and three top Natural Gas stocks “ Natural Gas Stocks: The Ultimate Form of Stored Solar Energy”.

Other methods of reaping gains in natural gas prices would be tracking ETFs. The most popular ETF, the United States Natural Gas Fund (UNG) has swelled their assets to over $4 Billion and causing distortions in the markets. UNG has also encountered issues with costs involved in rolling over their futures contracts. Here is a Seeking Alpha article by Lara Crigger explaining the differences between UNG and UNL, the newly launched ETF version intended to spread out the Natural Gas futures rollovers. Finally here is a guide to Natural Gas ETFs.

Leveraging the Trend for the Risk Amenable

Since the writer has a certain degree of confidence in the analysis and the possible U-turn coming, he is looking to maximize the possible gain. There is a leveraged two times fund named the Horizons BetaPro NYMEX Natural Gas Bull Plus ETF (HNU in Canada and HNUZF.PK in the US) managed by Horizons BetaPro Exchange Traded Funds. As described by their originator:

The HBP Bull+ ETFs and HBP Bear+ ETFs are designed to provide daily investment results, before fees and expenses, that correspond to double the daily performance, or double the inverse daily performance, respectively, of their specified underlying index or benchmark.

The writer’s understanding of leveraged ETFs is that the fund should perform satisfactorily if the trend is right, and moves directionally without much churning. The costs generated daily during the price churning will eat away at the gains. Also during a counter movement, the potential exists for a doubling of the leverage during the counter move, and thereby losses may be more than doubled.

Therefore, a heavy note of caution here is warranted as leveraged ETFs are risky and come with a whole slew of these issues such as tracking errors, significantly higher expenses and daily returns, not long term returns. Here is an older Seeking Alpha article detailing “The Case Against Leveraged ETFs”.

The HNU fund only tracks the domestic NYMEX spot price at the Henry Hub location. This limits the effects of other drivers of natural gas pricing and concentrates solely upon the supply and demand equation at the distribution point. See the chart following for the recent price action of the HNU ETF.



Figure 5: Horizons BetaPro NYMEX Natural Gas Bull Plus ETF. Note the dolji and 2 green days at the end. Source www.stockhouse.com

From examining the above chart, the bottom for HNU appears to be firming up with the dolji and two green days ending on November 20, 2009.

Conclusion

The general economic climate is in the beginning stages of recovery. The recovery in commodities prices and the Dry Baltic shipping index gives support to the idea of recovery. Natural Gas pricing fell with everything else and was slower to recover having being impacted with a glut of new supplies and the summer season of lower demand. The bottom for Natural Gas prices was already set in September, 2009. Now that winter is looming, the seasonal demand and price adjustments should soon be having an impact. Whether the pricing moves up this week or later, the trend should be upwards for Natural Gas from here.

Disclosure: The writer holds a long position in HNU.

Important Disclosure

The information and opinions contained within this document reflect the personal opinions and views of the author and should be view as information for thought and entertainment only. The author may from time to time have a position in any of the securities mentioned. Any material within should not be construed as accurate or reliable or be utilized as advice for investment or business purposes. Independent due diligence and discussions with one’s own investment and business advisor is strongly recommended. There are no guarantees of the accuracy or completeness of the information contained herein. These writing are not to be construed as an offer or solicitation with respect to the purchase or sale of any security or as an endorsement of any product or service. We do not receive or request compensation in any form in order to feature companies in this publication. It is prohibited to copy or redistribute this document to any type of third party without the express permission of the author. This document may be quoted, in context, provided proper credit is given.

Comments

[Plan B Economics]

Although inventories are growing, it appears that North American nat gas production is declining significantly. Not sure if this is due to shut-ins or depletion...

www.planbeconomics.com.../

2009 Nov 23 07:40 AM

[receipt]

Natural gas production STILL exceeds demand! The "injection season" was supposed to end on October 31. Instead, on November 13 natural gas in storage rose +25 Billion cubic feet to a record 3.78 Trillion cubic feet. MAXIMUM storage capacity in the USA is 3.89 Trillion cubic feet so at that time natural gas in storage in our nation was at 97.2% of total capacity. At that time 110 billion cubic feet of storage capacity remained unfilled ("empty").

On November 20th somebody forgot to tell the producers that "injection season" ended 3 weeks ago, because another 25 Billion cubic feet was stored, bringing total gas in storage to 3.813 Trillion Cubic Feet, or 10.0% greater than a year ago, and 12% greater than the average of the previous 5 years! These latest government reports show natural gas in storage at 97.9% of total capacity with only 77 Billion cubic feet of storage left.

Temperatures in the American midwest are 10-15 degrees above "normal". Would it really surprise anyone if, with a relatively warm fall obviously occuring, that the 3 weeks of storage capacity remaining would be fully utilized? What would happen to natural gas prices if Friday, November 27th, the government reports an additional natural gas injection into storage?

2009 Nov 23 08:47 AM

[Ferdinand E. Banks]

Very informative article. The gas market obviously deserves a lot of attention.

2009 Nov 23 09:25 AM

[SivBum]

With the introduction of UNL, hopefully speculative demand will help UNG.

2009 Nov 23 11:19 AM

[rc trader]

There really has been no rally at all in nat gas recently, hence the performance of UNG and other ETF's. Look at a chart of Dec futures, they just took out the Sept. lows and have had a nominal bounce the last two days. The entire "rally" has been the steep contango coming out of the market somewhat and even with a sharply (10-15%) colder winter heating season the odds are very good of entering next spring with still bloated inventories. A market which can't rally with a strong crude complex and a weak dollar does not merit investment at the current time.

2009 Nov 23 11:23 AM

[Marco G.]

Hello all, thank you for your comments.

Natural gas seems to have been given a small boost this morning. I don't know what to attribute it to, since there are all these messages about over supply and under demand. My thoughts are these:
1. Natural Gas is near bottom and can't stay here.
2. Markets are irrational, as witness the oil markets, though natural gas is less volatile; maybe just speculators driving.

2009 Nov 23 12:16 PM

[pmcvenu]

The writer mentioned that the HNU fund only tracks the domestic NYMEX spot price at the Henry Hub.

Any future ETF unless mentioned will track only near month future contract. for details you can visit the HBpro website regarding the contarct rollover details.

www.hbpetfs.com/pdf/Ho...

Venugopal PC

2009 Nov 23 01:04 PM

[Marco G.]

You are right about the close future month.
I meant to clarified that HNU only tracked at the Henry Hub, and some how I slipped and added spot price.
Thank you, I stand corrected.

2009 Nov 23 01:27 PM

[gastrader2005]

the theory on early September being the bottom has one problem: we've already made a new bottom. see F10 contract or Cal 10 contract.

2009 Nov 23 04:02 PM

[Commies are people too]

egad!

2009 Nov 23 05:22 PM

[Darcangelo]

Well written opinion.
There is a lot wrong with natural gas. Way too much supply, hot relative weather, slow economy and more supply.
The spread between nat gas and oil is almost historic but gas really tells the story of the health of the American economy.

2009 Nov 23 08:38 PM

[bob adamson]

Good to read your perspective, Marco G. Unfortunately, I can't share your optimism about natural gas future prices fully.

Obviously the future direction of natural gas prices is even more of an unknown than are many other aspects of the economic future.

Natural gas is only a fraction of the price that the historic ratio with the price of an equivalent BTU measure of oil would indicate. On the other hand, vast volumes of shale and deep offshore deposits that were inaccessible just a couple of years ago can now be accessed and brought to market with new technology. Both these factors only become relevant as the economy increases its willingness to employ natural gas in new ways or in greater volumes in substitution for other energy sources or if producers are satisfied that they can recover the higher initial costs of development of new sources by using the new technology. In today’s recessionary environment, these factors are more latent rather than active current market drivers.

Similarly, new or further potential uses of natural gas as a fuel and raw material for the production of fertilizers, plastics etc., particularly in the development of a greener economy, remain largely on the drawing board while the recession keeps the price of other power sources in check and makes capital for development of these new or future uses scarce.

One factor that in recent decades has induced major oil producers to acquire or prove natural gas properties (but not necessarily to extract and market the natural gas located in such properties) has been the SEC rules that allow such proven natural gas to be counted on a BTU equivalency basis when calculation proven oil life reserves. Proposed changes to SEC rules that would significantly liberalize the means of proving hydrocarbon deposits in the ground would make the proving of the vast shale and deep deposits of natural gas attractive for major oil producers to acquire and ‘prove’. However, unless the actual markets for natural gas itself improve substantially, natural gas from such expensive deposits will not be brought to market.

All the forgoing simply makes much more complex the already complicated pricing of natural gas based on transportation, seasonal weather, storage and other traditional factors.

Based on the forgoing outline, it is arguable that any significant sustained increase in demand for natural gas, while it would move the spot price up short term, would bring such large latent volumes into play within months that the price will not return to anything like the historic ratio (based on BTU equivalency with oil).

2009 Nov 23 10:46 PM

[raymond zhou]

I own 5800 shares of HNU.TO, accumulated since October 26, 2009 by dollar averaging, presently at a 26% of losses.
I did buy and sell over the September low and October high and made a few bucks.

my points are:
1. will there be another new bottom after 25th EIA inventory report, suppose xx amount more injections.
2. with time eroding effect, if I hold this doubled risk/rewards ETF, cont- ago might eat away everythng.

comments, please?

Raymond

2009 Nov 24 12:22 AM

[castle]

I feel that everyone agrees that much new supply of NG has been discovered. The important question to me is "How much does it cost to bring this new supply to market and is it more or less than the price today?" This is what we need to know to make intelligent decisions. However there has been published a lot of ambiguous answers


On Nov 23 10:46 PM bob adamson wrote:

> Good to read your perspective, Marco G. Unfortunately, I can't share
> your optimism about natural gas future prices fully.
>
> Obviously the future direction of natural gas prices is even more
> of an unknown than are many other aspects of the economic future.
>
>
> Natural gas is only a fraction of the price that the historic ratio
> with the price of an equivalent BTU measure of oil would indicate.
> On the other hand, vast volumes of shale and deep offshore deposits
> that were inaccessible just a couple of years ago can now be accessed
> and brought to market with new technology. Both these factors only
> become relevant as the economy increases its willingness to employ
> natural gas in new ways or in greater volumes in substitution for
> other energy sources or if producers are satisfied that they can
> recover the higher initial costs of development of new sources by
> using the new technology. In today’s recessionary environment, these
> factors are more latent rather than active current market drivers.
>
>
> Similarly, new or further potential uses of natural gas as a fuel
> and raw material for the production of fertilizers, plastics etc.,
> particularly in the development of a greener economy, remain largely
> on the drawing board while the recession keeps the price of other
> power sources in check and makes capital for development of these
> new or future uses scarce.
>
> One factor that in recent decades has induced major oil producers
> to acquire or prove natural gas properties (but not necessarily to
> extract and market the natural gas located in such properties) has
> been the SEC rules that allow such proven natural gas to be counted
> on a BTU equivalency basis when calculation proven oil life reserves.
> Proposed changes to SEC rules that would significantly liberalize
> the means of proving hydrocarbon deposits in the ground would make
> the proving of the vast shale and deep deposits of natural gas attractive
> for major oil producers to acquire and ‘prove’. However, unless the
> actual markets for natural gas itself improve substantially, natural
> gas from such expensive deposits will not be brought to market.<br/>
>
> All the forgoing simply makes much more complex the already complicated
> pricing of natural gas based on transportation, seasonal weather,
> storage and other traditional factors.
>
> Based on the forgoing outline, it is arguable that any significant
> sustained increase in demand for natural gas, while it would move
> the spot price up short term, would bring such large latent volumes
> into play within months that the price will not return to anything
> like the historic ratio (based on BTU equivalency with oil).

2009 Nov 24 05:50 AM

[Domino412]

I am still cautious on the NG play. I,m thinking it will at least come close to testing the 2.50 low. There is just too much gas out there. No demand with the mild winter. I'm buying into HNUZF slowly, but still thinking NG will hit mid $3 before marching higher.

2009 Nov 24 09:38 AM

[Marco G.]

I'm only a kind of curious investor, Raymond, but there is a very active blog on HNU at stockhouse, with lots of experts, and lots of day traders here:
www.stockhouse.com/Bul...

Good luck to both of us!


On Nov 24 12:22 AM raymond zhou wrote:

> I own 5800 shares of HNU.TO, accumulated since October 26, 2009 by
> dollar averaging, presently at a 26% of losses.
> I did buy and sell over the September low and October high and made
> a few bucks.
>
> my points are:
> 1. will there be another new bottom after 25th EIA inventory report,
> suppose xx amount more injections.
> 2. with time eroding effect, if I hold this doubled risk/rewards
> ETF, cont- ago might eat away everythng.
>
> comments, please?
>
> Raymond

2009 Nov 24 10:08 AM

[Maxe Paul]

It's basically a competition to see what is more worthless, the US dollar or Natural Gas.

Not much to cheer about IMO.

2009 Nov 24 11:55 AM

[MattZN]

Well, I think we are on the cusp of a major shift away from coal and towards natural gas. Momentum has been building for the last few years and production has clearly shown that a large, stable supply is available.

The limitation is in the infrastructure required to transport the natural gas to industrial consumers such as power stations, and the time it takes to build a new power plant or retrofit an existing one. Supply has gotten way ahead of demand. Regardless, switching from Coal to NG (or Nuclear) are the only real choices industrial fuel users have when it comes to meeting ever-stricter environmental regulations.

If you want to see what the future of power generation for the country will look like just look at power generation in California. It just might take 10-20 years for the rest of the country to get there. By the way, on the bright side of all of this... the lower NG prices are a huge boon for recession-gripped California.

It will be interesting to see what happens as supplies hit hard storage limits. Something has got to give somewhere. My expectation is that pipeline volumes will wind up going down in the short term but that NG producers will realize a great deal of savings as they focus more on the far more efficient horizontal wells. At the same time the weak dollar is making domestic supplies cheaper and imported LNG more expensive.

It is hard to say what this will do to unit prices for related MLPs. Spot prices are irrelevant in the MLP space but the capping out of storage could collapse the contango between spot and futures prices. It really depends on how long the state lasts. MLPs as a class tend to hedge production 1-2 years in advance so the whole thing could smooth out if demand continues to pick up. The future of the industry is bright but figuring out short term trends from that conclusion is difficult to say the least.

-Matt

2009 Nov 24 01:22 PM

[La Marque]

Quite a few valid points have been raised in comments. I am invested in NG by several means and am neutral in the short term. Electricity prices in much of the country are basically set by NG; and many states are forcing in alternate energy sources that will negate that fact. In Texas, the consumer deals directly with the generator and buys power by source such as wind power only or renewalable only. This reduces the market for NG.

A shift to hydrogen fuel cells would use a lot of NG - but don't count on it. Fleet usage of NG is the best use going forward relieving the pressure on oil prices.

The producers of NG are going to have to cap a lot of the new production just to keep up their margins and stock prices.

2009 Nov 24 02:02 PM

[Commies are people too]

"Ride U-Turn Up" ?

Sure, only if you promise to tell us before you dump your HNU.

2009 Nov 24 05:14 PM