The Timing Could Be Right To Buy Long-Term Options/Futures On Natural Gas

Mar.13.12 | About: Chesapeake Energy (CHK)

We have had a particularly warm winter. This has meant much lower than expected natural gas sales for heating during the winter. In fact, US household spending on natural gas this winter is on track to be the lowest in nine years. In last weeks' EIA report, US natural gas stocks were 48.3% above their 5 year average. This is putting severe pressure on natural gas prices. Nymex natural gas futures are at $2.22/mmBTU as I write. This is less than half of last summer's peak of approximately $4.98/mmBTU. Prices are so low that many natural gas E&P companies have cut back on their exploration efforts. Some, for example, like Chesapeake Energy (NYSE:CHK), have cut back on production considerably just to try to buoy natural gas prices. The trend is still downward, but we have to be getting close to a low.

There are several factors that may soon reverse this trend. First Japanese officials are asking a US delegation headed by Deputy Energy Secretary Daniel Poneman to allow exports of liquified natural gas [LNG] to Japan -- the world's biggest importer of LNG. If the US agrees, this could spur the development of the LNG export terminals. None are currently active, but the Sabine Pass liquefaction terminal development could be speeded up. There is also a planned terminal in Oregon that might be closer to Japan.

Second, Obama introduced natural gas use for the trucking industry as part of his US energy policy in his State of The Union address. The laws needed to spur the adoption of this have not been enacted yet. However, some are expecting approval by sometime this spring. This by itself would mean a huge bump up in natural gas usage. The announcement of approval would spur higher natural gas prices even in the short term.

Third, the US does have a number of liquefaction LNG terminals planned for export use. The first of these, the Sabine Pass terminal, is scheduled to go online in 2015. When these finally do enter the market (or even as they get closer to reality), they should put a floor under US natural gas prices. Prices in Europe and Asia are much higher. In Japan, they have been running over $15/mmBTU recently. Fourth the warm winter is almost over. Natural gas is used for cooling in the summer. In 2 to 4 months, the use of natural gas for cooling could possibly become a factor in buoying natural gas prices. If we had a warm winter, we may well have a warmer than normal summer.

Fifth, Chesapeake Energy and many other E&P companies have cut back on both their natural gas drilling and their natural gas production. Eventually this will help to stimulate demand. My overall point is that natural gas prices are not likely to go much lower, although some are suggesting natural gas prices will break the $2 level to the downside. Still this is not far from the current price. Longer term, the natural gas prices are due to rise due to the secular bull market in energy, as emerging markets demand more and more energy. China is already moving many autos onto natural gas. The US is simply behind the curve in all of this. The BP Energy Outlook predicts natural gas will be the fastest growing fossil fuel from 2010 to 2030, with nearly three times the growth rate of oil. This should cause a consistent and strong rise in natural gas prices over time.

Looking at the Henry Hub natural gas futures, the May and June 2016 futures look particularly attractive at $4.268 and $4.289 respectively. Both of these should give the LNG export industry and the natural gas for US trucking time to develop significantly. With the uncertainty in the current markets, this seems like a reasonable play. Keep in mind that US natural gas prices have historically been about 1/6 to 1/12 of oil prices. Natural gas prices are much less than that ratio currently. The profit potential is incredible. Since these are very long term futures, you may not want to buy them on margin. However, these may well provide an excellent opportunity to make money. If you wish to make a more uncertain bet, you might bet on March 2013 natural gas futures. However, I have no conviction that natural gas prices will reverse by then. For a those not afraid of a long term trade, this seems like an excellent opportunity.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.