Unless you live in southern California or southern Florida, baby it's cold outside. And the cold weather is drawing down natural gas storage at a record clip. Natural gas spot cash prices have already seen a super spike this week. If storage remains on track to fall below 1 trillion cubic feet, then the pricing of natural gas futures could be next to super spike. The latest EIA Natural Gas Weekly Storage Report shows natural gas storage has fallen to 1,923 billion cubic feet as of the week ending January 31, 2014. That is ahead of the pace needed for natural gas storage to fall under 1 trillion cubic feet on normal February and March weather as explained in the article Real Chance Natural Gas Storage Dips Under 1 Trillion Cubic Feet.
A picture is worth a thousand words. Here is a look at the actual cash spot markets for natural gas at various hubs around the country as reported by Natural Gas Intelligence:
|Trade Date: Feb 06; Flow Date(s): Feb 07|
|Col Gas TCO||$9.0000||$6.0000||$6.9688||-0.9646||495,200||86|
|Transco-Z6 (non-NY north)||$9.0000||$8.5000||$8.7626||-1.0303||117,500||18|
|Houston Ship Channel||$11.0000||$7.0000||$7.7533||-2.7361||64,700||13|
|Moss Bluff Inter||$9.5000||$6.5000||$7.3823||-1.0336||268,300||28|
Notice how the Henry Hub traded as high as $9 per mcf. The NYMEX Natural Gas Futures are based on trading at the Henry Hub. Yet those futures have yet to rise to $6 per mcf and are currently closer to $5 per mcf. The reason is most investors believe the couple of days of cold that caused fierce price competition will abate and that prices will fall back. But if storage falls under 1 trillion cubic feet that same fierce price competition for physical delivery of natural gas could erupt to make sure storage facilities are adequately filled to handle next winters demand.
Natural gas storage is well below normal in Canada just like it is in the lower 48 United States. This is exacerbating the competition for natural gas that flows both ways on both sides of the border. The EIA Weekly Natural Gas Storage Report details that last year natural gas storage fell 1,027 billion cubic feet after February 1. Last year February was warmer than normal. This year February has started out much colder than normal.
Investors looking to participate in a potential spike in natural gas futures prices have several options. They can make an investment in the United States Natural Gas Fund (NYSEARCA:UNG) which is based on the front month NYMEX natural gas futures contract. They can also look at the United States 12 Month Strip Fund (NYSEARCA:UNL) which is based on the natural gas futures for the next 12 months.
Another option is to look at a natural gas producing company that is not heavily hedged and is selling most of its natural gas in the cash spot markets at much higher prices than the futures markets. EXCO Resources (NYSE:XCO) traditionally has hedged only about half of its natural gas. Last summer it bought natural gas production in the Haynesville Shale from Chesapeake (CHK) for what is now looking like rock bottom prices. Contango (NYSEMKT:MCF) recently acquired Crimson Exploration to give itself exposure to oil and gas in the Woodbine and Buda formations. Prior to the acquisition Contango was an unhedged natural gas producer, but it did acquire some hedges with Crimson. It's 30% joint venture partner in the Buda oil and gas field U.S. Energy (NASDAQ:USEG) has no natural gas hedges and is getting only spot cash prices for its natural gas. Ultra Petroleum (NASDAQ:UPL) claims to be the lowest cost natural gas driller in the U.S. Cabot Oil and Gas (NYSE:COG) and Range Resources (NYSE:RRC) are leading natural gas producers in the prolific Marcellus Shale along with Chesapeake.
If storage is going to fall under 1 trillion cubic feet it won't happen until March. But the market will begin to price natural gas futures in advance once it perceives storage will fall under 1 trillion cubic feet. At this point, if cold remains in the forecast, then that could happen at any time. According to the EIA the last time natural gas storage fell under 1 trillion cubic feet was in 2003. Natural gas prices spiked higher that year. History could be setting up to repeat itself.
Disclosure: I am long MCF, UNG, USEG, UNL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.