As fall foliage is showing and temperatures are cooling down, investors are anxious to see what impact the rest of the year might have on natural gas producers. Conventional knowledge says that the weather is the determinant of short-term gas demand, i.e. warmer winter weather means less need for space heating and thus less demand for natural gas. However, understanding the fundamentals, i.e. how supply and demand forces change over time, is critical to analyzing the long-term trends in price and production.
With oil gaining a clear premium over gas, recently some large natural gas companies have been pessimistic about short-term gas production. McClendon of Chesapeake Energy (CHK), for example, stated that he didn't believe in an increase of natural gas production, given that CHK itself is switching to oil and natural gas liquids. Encana (ECA), in its recent investor presentation, also projected lower natural gas production leading to 2013 as opposed to associated gas. Both however believe in a market recovery in the long run.
There are two forces at play here. On the demand side, natural gas players do not want to miss the coming waves of demand from electric utilities, as coal plant retirements are increasing. The EIA projected that in the next 5 years, 27 gigawatts of coal-fired capacity will be retired. Remember that coal plant retirements are responsive to natural gas prices. Lower natural gas prices make it more attractive for utilities (not to mention higher efficiency gas-fired power plants) and therefore stronger demand for natural gas as a result. Nevertheless, on the supply side, low prices may lead producers to drop rigs or change the hydrocarbon mix to more oil. But with the fundamentals change on the demand side (preference for natural gas because of efficiency and lower environmental impact than coal), combined with more technological advances on the supply side, it's hard to believe production will see a downward pressure.
So should you jump on the bandwagon, avoiding anything related to natural gas as even the biggest producers themselves are switching to an oilier production?
Perhaps, if you feel like you can forecast the weather of this winter, which is, as I said above, the determinant of gas demand and you're assuming it's not going to be cold.
But will production go down, as said by Encana and Chesapeake? It's very likely that some production will be taken up by other producers. According to this press release, Southwestern Energy (SWN), for instance, is still drilling despite the challenging environment. Therefore the final production outcome is not that easy to find out.
I still believe this is a good time to get your hands on natural gas. With low valuation but a bright future, it will be the right way to go. Well, for those not too obsessed about media reports on the currently depressed natural gas prices and producers' massive abandonment and sell-off of gas assets. SWN, APA, and COG are some easy names I have on top of my mind.