Natural Gas: Evidence Of A Bottom?

by: R.J. Chopin

The Weekly Natural Gas Storage Report, released 3/15/12, reported further declines in US Natural Gas inventories (-64 Bcf). This marks the 17th. consecutive weekly decline for natural gas storage. Natural gas storage has declined from a Nov. 18, 2011 high of 3,852 Bcf to 2,369 Bcf reported on 3-15-12. This represents a 38% reduction in NG storage during the past 4 months. Weekly NGSR can be viewed for the past 18 years at EIA.

The conventional wisdom has called for shorting natural gas futures, but this is becoming an increasingly dangerous proposition. Shorting natural gas at this level poses a substantial risk of being trapped at the bottom. Back in 2002 when natural gas last traded at 2.23 level, natural gas jumped to the 4.00 range, then 6.00, and finally reaching 9.00 by 2003 (chart). The risk/reward ratio is clearly to the upside, and the pent-up potential is explosive. Overstaying your welcome ahead of a reversal can prove to be a painfully bad decision. As one trader told me, "prices are at a 10-year low, inventory shrinking, and producers cutting back, forget about shorting."

Natural gas producers are joining forces to boost prices. Chesapeake Energy (NYSE:CHK) the 2nd largest natural gas producer, announced that it would shut-in up to 1 billion cubic feet per day of natural gas. Conoco Phillips (NYSE:COP), also said it would shut-in about 100 million cubic feet per day. BG, The British Gas Company, a world leader in natural gas production, joins Chesapeake and Conoco in slashing natural gas production. Exxon (NYSE:XOM) Mobil said it had no plans to cut natural gas production. We expect other producers to announce cuts in the coming weeks.

According to Baker Hughes (NYSE:BHI), 7 more natural gas rigs shut down this week (3/16/12), fueling a 10 week consecutive decline. With only 663 rigs remaining, the lowest in 10 years, natural gas producers are implementing an action plan to decrease production (Reuters).

Myra Saefong of MarketWatch reported that Dan Gundersen, vice president of energy finance for Sandstorm Metals & Energy, based in Vancouver, Canada, (OTCPK:STTYF) made these comments:

Realistically, it will be difficult for prices to sustain current levels for an extended period due to the fact that current spot prices are approaching cash costs for marginal production.

A reduction in natural gas supply investment is evidenced by a steep decline in the natural gas rig count over the past 4-5 months.

Gundersen, raises an important point. The current price of natural gas is so near "cash cost" that "realistically" it is unsustainable. The empirical evidence is compelling. Natural gas producers are cutting back, shutting-in, scaling back, and closing down production because they refuse to sell natural gas at cost. As previously stated, storage inventories have fallen 38% in 4 months and the decline will continue. It is ridiculous to assume that natural gas producers will allow the price of natural gas to remain at current levels. A warmer than usual winter was the culprit for the natural gas build up, but as those inventories continue to decrease we should see the price recover to the 4.00 range. Those who ignore these facts are allowing their convictions to delude reality.

On the international stage natural gas exports will also increase demand for US natural gas. Infrastructure is ramping up for natural gas exports to more lucrative markets. Cheniere Energy (NYSEMKT:LNG) is building a 10 billion dollar natural gas export plant on the Louisiana Gulf Coast at Sabine Pass. Steve Hargreaves of CNN Money wrote:

To Cheniere and its supporters, the 500-plus acre, $10 billion plant represents a boon for the American economy.

Known as Sabine Pass, they say the facility will support tens of thousands of jobs, raise billions in export revenue, and help put the nation on track to be an energy-exporting powerhouse.

Across the pond, European natural gas prices are about 4 times the current U.S. natural gas price. As U.S. natural gas prices recover, the European natural gas market will remain very attractive and profitable for U.S. natural gas exports. Cheniere's Sabine Pass plant is planning to be online and well positioned to cash in on lucrative export profits.

Over the past 5 trading sessions natural gas futures contracts traded between 2.209 intra-day low on 3/13/12 and 2.393 high on Monday 3-19-12.

Investing Ideas: BOIL, UNG, GAZ, UNL, DBE, FCG

Disclosure: I am long BOIL.