Here is a long-term price chart for natural gas:
(Click to enlarge)
Please note that this chart is not adjusted for inflation. Adjusted for inflation, we are looking at 20-year lows in gas prices at a time when other energy prices are historically very high (oil at $120 a barrel for Brent, coal surging due to increased global demand.)
Oil and coal are easy to load on ships and transport to the developing world. Natural gas is less so, although at these prices several companies have announced plans to construct LNG export terminals in Louisiana. Such plans are foolish, however, because the current low natural gas prices are simply part of the natural volatility of domestic gas prices: Weather is unpredictable, natural gas wells deplete rapidly. Thus, when prices are high, drilling takes off. This then leads to oversupply and low prices. Drillers then pull back, which leads to under-supply and a price surge.
Just look at the above chart and tell me that you would have any confidence that prices will stay at $2 for very long. Really?
In the past four years, we have seen a fantastic drop in natural gas prices from $14 to under $2. Adjusted for inflation, this might even be seen as the end of a multi-decade long bear market in natural gas. Now the pendulum, having reached the full extent of its move, is ready to swing the other way.
At $2 per mmBTU even conventional production has become unprofitable. The hydraulic fracturing or "fracking" which has been responsible for the modestly increased supply in the U.S., will go away completely at these prices. And it won't come back until we are safely in the $8-10 range, especially when there is $100 oil to drill for in the Bakken.
Natural gas producers will just cap the wells and wait for the price to recover to profitable levels. The gas isn't going anywhere. Why sell it at these prices?
All the talk about storage being filled and prices going to zero reminds one of the talk about the Nasdaq Composite going to zero in the tech crash of 2002. It's just the silly kind of thing that gets said at a market bottom, probably by people who know we are at a bottom and are simultaneously going long in their own accounts, hoping you will be the one dumb enough to take the other side of the trade.
There is now only one direction for natural gas prices, and that is up. The only question is: How high will prices have to go to lure back the drillers who have been burned?
Contango has killed the United States Natural Gas Fund (NYSEARCA:UNG) over the past several years. The fund has fallen from a split-adjusted $506.64 to its current price at around $15 dollars a share. That's a stunning loss of 97% over four years.
However, contango is a natural feature of declining markets which expect a return to "normal" prices. A sustained bull market in nat gas could give us backwardation in prices which will mean that front-month funds like UNG will outperform a strategy of buying and holding longer-term contracts.
I'm not going to predict that UNG will return to $506.64 anytime soon. But rather, should natural gas futures go into backwardation and the price of the underlying commodity continue to rise, as indeed it will, UNG will do just fine.