Long term readers are well aware of my antipathy towards natural gas, which has been in your worst nightmare of a bear market for the past three years.
Well, the simple molecule finally got some good news last week. First, major producer, Chesapeake Energy (NYSE:CHK) announced that it was cutting its natural gas production by 50%, taking some immediate pressure off the market. Sure, (CHK) is just one company, but others may follow suit.
Second, at the urging of my friend, Boone Pickens, Present Obama announced funding of some natural gas corridors in his State of the Union address. These are chains of natural gas stations placed every 100 miles stretching from east to west and north to south that would allow heavy trucks on transcontinental routes to refuel. This would provide the extra incentive for these 18 wheelers to convert from diesel fuel to CH4 at a nominal cost and put a major dent in our oil imports.
The news was enough to trigger a massive short covering rally in this most unloved of molecules. The spot market soared 25%, from $2.25 to $2.82 per MBTU's, while the ETF (NYSEARCA:UNG) leapt from $5 to $6.
I am going to call the bluff of the market here and buy the United States Natural Gas Fund April, 2012 $6 puts at $0.65 or best. That way I can take advantage of the huge contango that exists between the spot and forward markets for natural gas futures contracts. To avoid actually drilling its own wells, the (UNG) buys forward contracts at huge premiums and holds them until they expire at spot. They then roll the cash forward into new contracts and repeat the process. It is one of the best wealth destruction machines I have ever seen and explains why (UNG) has, by far, outperformed natural gas on the downside. It is a great thing to be short.
To see how extreme this contango is, please visit the CME website at http://www.cmegroup.com/trading/energy/natural-gas/natural-gas.html . June futures natural gas futures are trading at a 10% premium to March, which is more than 40% annualized. All of that premium goes to money heaven for the (UNG).
If (UNG) double bottoms at $5, the put options should double in value. If a continuing glut of gas breaks us down to new lows, you could make much more. With the industry expected to run out of new storage capacity by the summer, I am betting on the latter, hence the heavy position. One other thing worth knowing here is that once drilled with the fracking process, you cannot turn off or cap a natural gas well without damaging the output. There is no "OFF" switch.
For a much more detailed explanation on why natural gas is in dire straits, please click here at http://www.madhedgefundtrader.com/natural-gas-goes-down-in-flames/ . Subscribers to my Global Trading Dispatch received this research piece as a trade alert on Monday. To subscribe to the Mad Hedge Fund Trader's Trade Alert Service, please go to my website at www.madhedgefundtrader.com , find the Global Trading Dispatch box on the right, and click on the lime green "SUBSCRIBE NOW" button at the bottom.