LOLcapitalist, CFA

Another Natural Gas Bull Sticks His Neck Out

Your lack of understanding of the global natural gas market is embarrassing. Please confine your comments to subjects that you may add to the conversation in some meaningful way.

I won't point out all of your errors as they are too numerous. (In fact, I'm impressed at how many ways one can be wrong in so few words.) You are careless with your terms ("majors" means something to people who know oil&gas and there will be no bankruptcies among them) and you idea of UNG being a "buyer of last resort" demonstrates a deep and fundamental misunderstanding of the North American Natural Gas Market.

I am ignoring the old adage about arguing with a fool; however, please stop clouding these discussions with shots-from-the-hip regurgitation of what you hear on CNBC.

On Sep 03 11:03 AM Mad Hedge Fund Trader wrote:

> bring on the guillotine. Just when I get comfortable with my view
> on Natural Gas, I get a scratchy, reverberating cell phone call from
> one of the major formations telling me that I’m being way too bullish.
> Gas won’t bottom at $2. The free fall will continue until it hits
> $1. National storage will be completely full imminently top out,
> and when it does, the producers will have to shut down completely.
> Since these guys are leveraged up the wazoo, this will trigger a
> string of bankruptcies, and the majors will fall like dominoes. A
> hedge fund bust won’t define this bottom, as these guys are all playing
> from the short side. UNG can’t step in as a buyer of last resort,
> as the SEC won’t let it issue more stock, and the current shares
> are trading at a ridiculous 20% premium. One thing we do agree on
> is that the bottom will look ugly, whatever the spark is. Well, it
> takes two to make a market. Conclusion: keep NG nailed to your screen,
> as the widow maker is where the volatility lives.

China's Growth: Far Less than Meets the Eye

I agree with the author, particularly with respect to Chinese demand for commodities. Here is an excellent explanation of the current action in the copper market from Simon Hunt (via John Mauldin):

"There is no better example of this [Chinese] speculative activity than what is being seen in the copper market. It is easy for global merchants, hedge funds etc to ship cathode into China and warehouse it outside the reporting system, so fueling investors' sentiments that copper demand in China is soaring and at the same time draining copper from the rest of the market.

"It is not so much industry which is doing this buying in China, but individuals, financial institutions and even small companies divorced from the copper industry who are buying and holding the metal because copper is a store of value and prices will go up is the common response. We updated our numbers for the first half of this year. They are truly staggering. Over 1 million tonnes of cathode is sitting in China mostly outside the reporting system as a punt on rising prices."

The End of the End: Much Needed Perspective on 'Recession Is Over' Debate

Excellent work, as always. About the only constructive thing I could add to your presentation is an idea about what's going on in the seasonal adjustments for unemployment. Historically, the auto industry lays off during the summer so the unemployment numbers are corrected for this "false" unemployment because these workers are understood to be going back to work after a short break. This year the auto industry let workers go much earlier (and in many cases permanently). The current seasonal adjustment then is mistaking actual job losses for the temporary auto industry job losses it expects to see and is, therefore, ignoring a material number of real job losses. This may not totally explain it, but I suspect it's a big part of the error.

Noticed the Oil Backup?

This is a little off the subject, so I apologize in advance and give fair warning to stop reading if you like.

China has also made credit available as part of their stimulus package equal to approximately 1/3 of GDP. That's like the US forcing $4.5 trillion through the banking system into loans with virtually no credit quality. Chinese money supply expanded 28.5% in June 2009 (yes, in one month) alone. No credible person (who is aware of the situation) thinks there won't be severe consequences resulting from the debt bubble currently being created in China's already near-insolvent banking system. Combine that with an untenable internal geopolitical position and it seems to me that there's more downside in China than upside.

The funny thing is everything looks like it's going amazingly well (people buying cars, building office buildings, etc.) right up until they hit the wall. We have only to look at the US housing bubble to see a less severe example of the bursting of a massive asset bubble funded by debt.

Sorry, I know I'm a tiny minority here, but I'm not an optimist on China.


On Jul 26 12:54 AM China Yankee wrote:

> buyforeclose ----
>
> I am sure you are a great realtor and under stand what is happening
> in California but you are OFF a bit when it comes to China .
>
> I am an expat working in China and I can tell you that right now
> the cars on the streets are exploding .China is now selling more
> cars then the USA .They have lowered taxes on new cars and made loans
> available to most of the people .GM and Ford are making good profits
> in China .
>
> The cars on the road in India are also increasing dramaticly , not
> to mention Vietnam - Indonesia -Brazil . The price of oil MAY go
> down to the high 50,s because of the surplus now but will be higher
> by the end of the year .

What (or When) Is Up with Natural Gas

The relative E&P economics are irrelevant when the commodities are not marginal substitutes.

Your point might make sense if there was an actual choice for an individual producer whether to devote E&P budget to oil rather than gas, but that's not true in North America. The marginal gas production is in shale plays, which to totally different (geologically, geographically, technically) from oil. In North America, very, very few producers have the technical and financial strength to make the decision, year by year, whether to pursue oil or gas.

You are absolutely correct that NG supply won't hold up at $4.00, but that has nothing to do with the price of oil. If you want to bet NG is going to rise then by all means do so. My point is that there is no good reason to package it with a bet that oil will fall. That is an assessment.


On Jul 09 05:40 PM Daxtatter wrote:

> LOLCapitalist:
> The ratio between WTI and nat gas would presumably be due to the
> relative ease on a BTU basis for drilling for natural gas than oil
> (long term price=marginal cost), and while shale gas has reduced
> the price of drilling and the cost of leasing reserves, it hasn't
> cut it by 2/3s compared to oil. So while the cost should have come
> down relative to oil due to higher supply and lower demand, the price
> will have a big impact on natural gas supply, hence the more than
> halving of the number of nat gas drilling rigs. Supply simply won't
> hold up under $4 per MMBTU.

What (or When) Is Up with Natural Gas

It never ceases to amaze me the extent to which the WTI/NG ratio myth is ingrained in the minds of so many traders. Let me be perfectly clear: the prices for North American Natural Gas and Crude Oil in North American have absolutely nothing do do with one another except to the extent that they are both driven (to some extent but far from exclusively) by GDP growth expectations. Here are two significant reasons:

1) They are not marginal substitutes for each other so the $/MMBTU argument is meaningless. Can anyone name a major consuming sector for oil that can easily switch to NG? It's like saying Big Macs and carrots should trade at caloric parity.

2) Oil is priced globally, gas is still largely local. If you pull oil out of the ground in Louisiana you could sell it in the UK if the transportation economics made sense. That just not possible for natural gas. North American Natural Gas is stored and consumed in North America. LNG is still a one-way supply line into, but not out of, North America.

For a statistical analysis of the WTI/NG relationship, see my instablog. We really need to stop obsessing about this non-existent relationship.

Natural Gas Oversupply to Weigh on Oil Prices?

I don't understand why we keep discussing the WTI/NG relationship as if it has meaning. I've posted on this subject. For a statistical and fundamental analysis, see my instablog. There's no reason to post it here.

Felixd: you're assertion about F&D costs for marginal production in North America is incorrect. Some of the shales have F&D costs below $2.00.

Natural Gas: The Next Big Thing

Syntroleum (SYNM) has been trying to make the Fischer-Tropsch (FT) process (which is the process you're referring to) work economically for years. There's no question that it works. In addition to the Germans, the South Africans made virtually all of their liquid transportation fuel during the period of apartheid sanctions from coal using the FT process. It's dirty (like most coal) and at best only marginally cost effective. Add the cost of carbon sequestration and it's a non-starter.


On Jun 18 08:43 AM bigbuilder13 wrote:

> It seems to me that there is a great disconnect between long term
> fundamentals and short term trading. I have made more money with
> NG than I have lost so I am sort of hooked on NG as an investment.
> However, I fear that forces beyond my control could whipsaw the markets
> for NG and the stocks of the E and P firms. Therefore, I am essentially
> out of the market for the time being.
>
> I wonder why someone has not looked at using cheap NG as a power
> source for the conversion of coal to diesel. I know there is a way
> to make oil (and its byproducts) from coal; the Germans did it in
> WWII. IF the wind power and cheap NG of the Rockies were applied
> to create electricity, then that power could convert cheap western
> coal to diesel and provide domestic fuel for trucks and cars. There
> would be no need for a huge investment in electric grid; the diesel
> would move by pipeline. Just a random thought; guess the economics
> won't work...if they did, others would be talking about it.

Natural Gas: The Next Big Thing

There really isn't much good data on what happens to flow rates when you shut in a shale well (that's what I assume Mad Hedge Fund Trader is referring to). The vast majority of the economics are in the first 4 years (because of the steep decline rates) so I don't know of anyone who's taken the risk on shutting them in during that time frame.

Liquefying natural gas purely for storage is uneconomic.


On Jun 15 06:48 PM User 400728 wrote:

> There are no significant large capacity liquifaction plants for LNG
> in the USA that I am aware of that could store some of the excess
> gas. If hydrafraced wells can't be shut in without harming future
> flow rates, then this is a real problem. I know they use a hard material
> that is pumped with the slurry to hold the fracture fissures open
> to let the gas flow. What happens if the well is shut in?

Natural Gas: The Next Big Thing

This story sounds great and has an excellent "megatrend" idea behind it. Unfortunately, like most good stories, this one is largely fiction. Let me offer an opposing view.

First, there are reasons oil trades at a significant premium to natural gas. Oil enjoys huge cost advantages in transportation and storage (this has been pointed out already in the comments, but it bears repeating). In practice, oil is a truly global market. All else being equal, the difference between the oil price at point A and point B will be the transportation differential, including cost of capital in transit. Not so for natural gas. Other than LNG, natural gas is limited by pipeline access, so is largely priced locally. Also, the US is the only free market for natural gas. The rest of the world heavily regulates pricing so when discussing NG, we should understand that we are actually talking about Henry Hub, which is the reference price for North American natural gas. WTI, on the other hand, is one of the primary reference points for global oil prices (even though delivery is at Cushing, OK) so forces in the North American gas market can have an out-sized effect on the oil/NG price differential when stated in terms of WTI and Henry Hub. This is the case today. The pricing case for NG can never rest on the oil/NG relative price argument.

Second, it is a dangerous game to bet on the outcome of a new regulatory regime such as carbon taxes. Much more go into these regulations than the stated intent of the legislation. And, as has been hinted at in the comments, no carbon tax (I include cap&trade in this category because it's just a different form of carbon tax) can pass the House without significant support from coal state Democrats. That support will not be forthcoming for legislation that gives natural gas a regulatory advantage over coal.

Third, the huge shale plays such as the Marcellus (W. Virginia and Pennsylvania mostly) and Haynesville (which is in Louisiana, not Alabama) do, in fact, have the potential to satisfy North American demand for decades at least and at prices below $10. (And before you ask, yes, most of the published data is wrong.) The interesting characteristic is that these wells blow down at 65%-80%+ in the first year. This means that meaningful supply adjustments will lag a drop in rig count by at least a year. However, working against this is the necessity for shale players to develop properties to retain the leases for which many of them paid large bonuses over the last couple of years. So we are looking at an oversupplied market through mid 2010 at least. Unless, of course, the shale players hedge out into 10 and start drilling again (a very plausible scenario) in which case we will see oversupply through 11-12.

Fourth, as someone else pointed out, there is a huge wave of LNG heading for shore (somewhere) over the next five years. Most of the new contracts have diversion rights so this LNG will seek the highest priced markets which is seldom North America; however, this does not mean LNG will not hit our shores. Once a large liquifaction train starts up it only stops for maintenance. These projects are heavily leveraged so require cash flow to pay the debt. This means that global LNG supply does not adjust to global demand. New LNG always seeks the highest priced market net of transportation and diversion costs, regardless of what that price is. This means there will be times when the US acts as the global "sink" for LNG even if the market is already oversupplied.

Finally, while I agree that NG is an obvious "transition fuel", this is not tradeable information unless one has a time horizon measured in decades. In any case, the way to play it would not be using the prompt month contract.

Pricing Oil in Big Macs

The most surprising thing about this chart to me is the variability. Aside from the labor to assemble the burgers, Big Macs are essentially made from oil & gas. Large amounts of nitrogen fertilizer [natural gas is a primary input in the production of nitrogen fertilizers] and diesel fuel are used to grow corn, which is converted into beef and, to a lesser extent, cheese. Same for the lettuce and grains. Diesel is used throughout the transportation chain and a significant chunk of the electricity for the processing plants comes from gas-fired generation. I would guess that most of the variability in the chart actually comes from the real-time nature of the oil markets versus the relative stickiness of retail pricing for a global QSR like McDonald's.

Goldman Sachs: Why Aren't Trading Profits Raising Any Red Flags?

I'm guessing the 12.5% is window dressing. Can't you just see the guys sitting around a conference room off the trading floor saying things like "nobody'd believe 100% even from us" or "let's give back an 1/8 - we gotta keep 'em in the game"? I doubt they're actually lying, but this definitely has a kind of Enron feel to it with respect to market manipulation.


On May 06 03:09 PM Vuke wrote:

> When you make a market it's pretty easy to be onside 87.5% of the
> time.
>
> The amazing accomplishment is being offside 12.5%. Fire those traders
> and let the cream rise to the top.

One Trillion Dollar Commercial Real Estate Time Bomb Now Ticking

Excellent piece - just the sort of thing we've come to expect from you.

I'd like to expand the discussion to the broader asset market. At the end of the day, the problem is that asset values have fallen below the value of associated debt. This is true across virtually every asset class and geography. The leadership at the Fed and the Treasury appear to be flailing about because they are bouncing along trying to appear to deal with the asset-bubble-of-the-day with no apparent cohesive plan. Unfortunately, this seems to be the furtherest thing from the truth.

Ultimately there are only two resolutions to this situation. Either lenders continue to take massive and repeated write-downs or the Fed and Treasury inflate away enough of the debt to create an acceptable amount of equity in the aggregate capital structure (remember, the debt is priced in fixed dollars while the asset values rise in an inflationary environment). The latter seems to be the broad strategy being pursued by our financial leadership. While there are many obvious problems with this approach, the one that bothers me most is that they appear to be operating under the delusional assumption that they can create some kind of controlled inflation.

Thoughts?