Phil Flynn: Buy NatGas Below $4, Expect $7 By 2015; Oil Can Move Either Way With Russia

 |  Includes: GAZ, UNG
by: Hard Assets Investor

By Sumit Roy

Phil Flynn is senior energy analyst and a futures account executive at Chicago-based The Price Futures Group. He is one of the world's leading energy market analysts and a daily contributor to Fox Business Network, where he provides market updates and analysis. HAI Managing Editor Sumit Roy recently caught up with Flynn to discuss the latest developments in the energy markets.

HardAssetsInvestor: Do you agree with the view that natural gas production will surge and inventories will easily be refilled by next winter?

Phil Flynn: There is a belief out there that this winter was a fluke, and that somehow we'll be able to produce natural gas at a record amount to refill storage. But I don't know if the market is overly optimistic. There's absolutely no doubt that the dynamic for natural gas in this country has changed because of the shale gas revolution. But what happened this winter really unmasked a lot of the issues that we still have, and that is that the infrastructure in this country is inadequate to deliver gas when it's needed.

We've also seen that because of low prices, the demand for natural gas has gone up. Not only are we producing a record amount, we're having record demand. And that's a good thing. But if natural gas demand continues to grow, we're going to have to have prices at a level that's going to encourage more production growth and more infrastructure spending.

So prices aren't up more because we know we have a lot in the bin, and that we should be able to produce a record amount. The reason I don't think they're going to fall too much further is because of some of the issues that I mentioned.

If you look at the natural gas market, it looks like it wants to really fall apart again. But they better be careful, because if prices fall too far, we lose the incentive to produce and get storage levels back up.

HAI: What's your price outlook for this year?

Flynn: My price outlook from two years hasn't changed. We expect that natural gas prices will hit $7/mmbtu by 2015. By the way, when I came out and said that natural gas could hit $7 by 2015, there were a lot of naysayers out there who said I was crazy, that we'd never get back to $7. Well, we hit $6.50 just last month. And we're still vulnerable for those types of price spikes if we get bigger demand.

It's kind of a wake-up call. We got a little bit too complacent with the natural gas market the last couple years. There was a sense that, "Hey, we're producing much; we're burning it off; we'll never use it." Well, that's only part of the equation. The other part of the equation is getting it to where it needs to be when it has to be there.

Look at what happened in New York City. You got prices shooting up to over $100 when it was cold. In California, we saw record highs. In New York, you're sitting next to the Marcellus Shale, the biggest resource in the country, and you're importing natural gas from the Gulf. What's wrong with this picture? Well, it's infrastructure. All these things need to get worked out, but it's not going to happen if prices get too cheap.

HAI: What prices do you think traders should be looking at to accumulate positions?

Flynn: Anything below $4 would be looked at as a buying opportunity. If we fall too far below $4, you're going to lose that incentive to get storage up to where it needs to be. Also, if you're not making a lot of money on selling the natural gas, there's going to be less incentive to invest in the infrastructure. If you want long-term, stable prices of natural gas, you really have to keep prices high enough to keep the incentives going. It's a delicate balance.

HAI: What part of the futures curve should traders be looking at?

Flynn: We were recommending buying 2015 calls for a while, or 2016. If it were me, I would try to go cheap and long term. But the problem is with the natural gas options, it's hard to get a market. You have to really work to get a fill. But I think if you're patient and you keep putting the bids out there at a reasonable price, you should be able to get that.

HAI: When will natural gas exports start having an effect on the market?

Flynn: They already are; that's the untold story here. We keep talking about LNG exports, and that's going to happen. But you also have to look at what's happening with Mexico, for example, where exports are growing. We're also importing less from Canada. Look at Canada's supply. They had a very cold winter; their supplies are tight as well.

Now, as for LNG, everybody says, "Well, if we start exporting natural gas, we're going to lose our competitive advantage." To me, that's a bad argument. A lot of people want to build an economic wall around us and withhold our supply, but the U.S. is going to be more effective if we are able to be a worldwide energy hub. I'd like to see us be a major exporter. And by doing so, we're also going to create more customers.

It doesn't do us any good if we have this low-priced natural gas and this booming manufacturing sector when other countries can't afford to buy our stuff because they're paying too much for their heating bills. People who want to block exports are thinking short term as opposed to the big picture.

HAI: Turning to the oil market, what are the biggest upside and downside risks that you see for crude oil? Is Russia even a factor?

Flynn: Russia is a factor in the short term. Right now there are sanctions going back and forth, but if this escalates into a war and there's a cutoff to Russian supply, obviously Europe has to replace that. So your risk is there. Another risk is that if we get into a shooting war, pipelines can be blown up and transportation routes can be wiped out.

I know the market was very quick to say "Oh, he's got Crimea, he's not going to go anywhere else; everything is hunky dory." Anybody who's saying that doesn't know history, even recent history with Vladimir Putin. He's cut off supply to Georgia, he's cut off supply to Yugoslavia. Putin's track record is that he will use energy as a weapon.

Big picture, it's going to come back and haunt him. Obviously, it's not helping the Russian economy right now. He's going to lose market share, because any country that wants a reliable supplier isn't going to be able to look at Russia the same way. Europe has been desperately looking for alternatives and they continue to do so. It's also going to increase the probability that the U.S. is going to get more natural gas and possibly oil exports approved.

There are definitely a lot of risks to the upside, but there are downside risks as well. This situation in Eastern Europe could damage the emerging-market economies, which are already having a hard time because the Fed is raising interest rates. If we get into a Cold War-type atmosphere; if we continue with the sanctions back and forth, the economies in emerging markets could slow, demand could slow, and you could see the price of oil absolutely collapse.

So if you get into a hot war, prices could go up. If you get into a cold war, it could damage the economy, and it could reduce demand and push prices down. There's definitely a lot of risk both ways.

HAI: Interestingly, we've actually seen U.S. oil outperforming Brent, despite the Russia situation. I guess that's due to that Seaway pipeline announcement last week.

Flynn: That's a big part of it. It's the expansion of the Seaway and also the startup of the southern leg of the Keystone. A couple years ago, I said that at one point, WTI would regain its status as the global benchmark, and I think that's what's happening here. We're adjusting more to the global price; more people are going to look at America, as opposed to the Brent crude contract, because we're going to have a more reliable amount of supply.

We're going to be one of the biggest consumers, one of the biggest exporters, one of the biggest importers, you name it. So the global energy world's going to go through the United States. At least in the short term, this pipeline news is bringing up our price. But it will bring down our price for products like gasoline and diesel over the long run.

HAI: Do you think the WTI-Brent spread could hit parity this year?

Flynn: Over time, it's going to hit parity. Last year, we actually saw WTI go to a premium, but then we backed off because of the geopolitical risk and other issues. It looks like we're going to get to parity again; it wouldn't surprise me.