This winter's record warmth has slowed demand and increased the huge glut of natural gas. The Northeast U.S. had the 4th warmest December in 117 years and something we began forecasting back in December, because of the +AO/NAO index and other climatological factors. The weather forecast for this weekend and much of next week is for some near or record warm weather temperatures and is "one" key reason in natural gas prices falling some 10% since last week.
Below I discuss some of the fundamentals of this market and touch on a few industries and stocks that may benefit from the lower prices.
LOW NATURAL GAS PRICES A SHOT IN THE ARM FOR SOME SECTORS OF THE U.S. ECONOMY
More than half of all U.S. Households use natural gas for heating and 25% of the nation's electricity is made from it. The recent fall in natural gas prices is offsetting the impact of high gasoline prices and allowing families and small businesses to spend money on other things. Companies that make plastics, fertilizers and other chemicals derived from natural gas are likely getting a great 'shot in the arm'. Even those companies that make products such as steel and beer use natural gas and the result of the glut of supply and mild winter has and will allow U.S. Manufacturers to become more competitive globally. What a contrast to when natural gas futures hit nearly $15 per thousand cubic feet in 2005. Chemical and metals manufacturers were shutting down U.S. Factories and moving overseas, where gas was abundant and cheaper. Farmers in need of fertilizer were turning to inexpensive imports from Canada, Trinidad and Asia.
CF industries (NYSE:CF), for example, that makes fertilizer ingredients and ammonia, has seen their natural gas costs fall from $6 million to $2 million the last few years. As a result, the company is expected to spend more than $1 billion expanding their plants here in the U.S. Their stock has appreciated some 20% during this very mild winter. The same might go for companies such as Dow Chemical (NYSE:DOW) and feed producers like Intrepid Potash, Inc. (NYSE:IPI) and the Mosaic Company (NYSE:MOS), who also benefit from low natural gas prices.
While lower natural gas prices may be a benefit for you and me (the homeowner) and certain industries, such as the ones mentioned above, the profits of electric power producers are shrinking and Chesapeake Energy Corporation (NYSE:CHK) has seen their stock price drop about 10% this last week, as natural gas prices have fallen from $3.00 to $2.50 in the futures market.
WHAT ABOUT COAL?
According to First Enercast Financial --
"Currently, we have probably picked up all the new gas fired generation demand we will get at current rates but we are about to enter a price point for natural gas that makes it cheaper to burn than Powder River Basin coal. Powder River Basin coal is the cheapest source of coal in the U.S. and supplies roughly 40% of the nations coal. At current PRB prices, natural gas will begin to be cheaper to burn at prices below $2.50 for many regions in the West and some Midwest markets. This is a huge amount of potential new demand that can possibly materialize in 2012 if natural gas prices remain weak.
If natural gas prices can remain below PRB for an extended period, there is around 4-6 bcf/day of total new demand that could be created over the next year. This is because there is still plenty of spare idle gas fired generation capacity.
The impact of this will appear most pronounced in the spring period when coal and nuke generation is offline. The maintenance season will become longer and more heavily support gas demand as coal plants come offline for extended periods to retrofit with scrubbers. There are around 500 coal plants that will be retrofitting with scrubbers over the next 3-4 years and a typical job takes 3-4 months."
HUGE STORAGE REMAINS THE MAIN ISSUE
This remains the primary problem in the current natural market. Storage must be drawn below 2.5 tcf by the end of March to avoid damage and loss of gas to many aquifer and reservoir storage units.
Facilities have contractual agreements requiring storage holders to remove gas or face steep penalties. With the updated storage forecast, we may have difficulty getting total stocks below 2.5tcf this season. This has caused fear in the market that storage operators will just dump gas onto the market, collapsing prices temporarily. This mindset seems to be getting priced in currently.
Based on preliminary storage estimates (based on my weather forecasts) below I show the projected storage projections of natural gas, by First EnerCast Financial.
Jan 19 report: -75
Jan 26 report: -146
Feb 2 report: -69
Feb 9 report: -71
Feb 16 report: -99
SOURCE: FIRST ENERCAST FINANCIAL
Large speculators increased net short interest last week for the first time in 8 weeks. But the majority of the selling has been from ETF funds which are net long. Those funds retained nearly 400,000 long March gas contracts, as of last week. So the bleeding can continue for a little longer, as our continued forecast for warm weather returning might mean prices fall close to $2.00
NATURAL GAS EARNINGS AND WHAT IS NEEDED TO EAT INTO SUPPLIES
Over the next two weeks, producer 4th quarter earnings will be released along with 2012 capital budgets. This will be very important as we will see if current natural gas price weakness has altered natural gas development plans by the producers.
There are several natural gas producers setting fresh 52 week lows in their stock value recently. Still the majority have enough oil production to shield their valuation from natural gas weakness. Unfortunately, we may need to see a severe crash in some producer stocks and a cut off of financing to these companies to get them to slow output. So far valuations remain too high to discourage production. Unless oil prices can come down, natural gas supply will likely continue to stay elevated.
It is fairly common that during unusually warm early-mid U.S. Winters, the late winter and/or spring tends to be colder than normal, but it may take extreme sustained cold weather and government regulation to shut down some fracking operations, to really get natural gas prices out of the doldrums, something that might not happen for a long time. It's also possible that natural gas drilling could be curtailed by environmental regulations designed to protect drinking water from hydraulic fracturing.
Natural gas prices could at least temporarily bottom in my opinion as we head into spring. Often traders and hedgers begin gearing up for summer cooling demand and buying ahead of the hurricane season but as far as a major long term bull market, this may not happen for years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.