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Coming This Fall: A Natural Gas Price Rebound

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Interesting article with some projections that may or may not come true, a good read none the less. Do good research before you make investment decisions. JLCpulse

Submitted by Wall St. Daily using our Trefis Contributor Tool

Natural gas is what my colleague and Wall Street Daily Chief Investment Strategist, Louis Basenese, calls “the most hated commodity in the world.”

It’s a well-earned moniker, considering natural gas prices have dropped more than 50% from their 2011 peak.

And with many meteorologists predicting a cool summer for the United States – after the fourth warmest winter in recorded history – natural gas prices could have even further to fall.

The good news, though, is that once natural gas prices do bottom out, they’ll have nowhere to go but up. And they’ll probably find the floor sooner than you think.

In fact, I’m predicting they’ll start bouncing back this fall.

There are three big reasons why: production cuts, increased demand from power plants and widespread use in transportation.

– Natural Gas Rebound Reason #1: Production Cuts

First, natural gas companies and oil majors with expansive natural gas operations are cutting production to avoid adding to the supply glut already on the market.

Exxon Mobil’s (NYSE: XOM) oil and natural gas production dropped 5% in the first quarter. ConocoPhillips’ (NYSE: COP) oil and gas output fell 3.8% in the first quarter. And EnCana (NYSE: ECA), Canada’s largest natural gas producer, said it plans to reduce its output by 600 million cubic feet a day.

“There is a current weakness in market fundamentals due to an oversupply of natural gas and it is clear that a continued reduction of drilling activity will be required to restore market balance,” EnCana said in its earnings release.

The number of rigs drilling for natural gas is indeed on the decline, having fallen 22% this year, according to Baker Hughes (NYSE: BHI).

And if mild summer weather adds to the supply glut, producers will be forced to cut back even further.

– Natural Gas Rebound Reason #2: Increased Demand

In the meantime, more and more power plants are switching to natural gas, which is cheaper and cleaner than both oil and coal.

Gas costs for power plants fell to the equivalent of $1.3783 per million British thermal units (btu) less than coal last month – the biggest discount since coal futures began trading in 2001, according to Bloomberg data.

Crude oil is eight times as expensive as natural gas when comparing equal amounts of energy produced, and would still be four times as expensive even if gas prices were to rise by 75%.

As a result, power companies have increased natural gas use by about one-third over the past year, according to Energy Department data.

American Electric Power Co., the biggest producer of coal-fueled electricity in the country, said on April 20 that it used 62% more gas in the first three months of the year. And Thomas Fanning, Chairman and CEO of the Southern Co. (NYSE: SO) – once the largest U.S. consumer of coal – told Bloomberg that his company expects to generate 57% of its power from natural gas by 2020.

Natural Gas Rebound Reason #4: Transportation’s Eating it Up

Power companies aren’t the only ones repositioning themselves to take advantage of the cheaper fuel, either. The steep decline in natural gas prices has also stirred more interest in the transportation sector – especially among companies with large vehicle fleets.

For example, AT&T (NYSE: T) began sniffing out opportunities back in 2009. At that time, the company promised to buy 15,000 alternative fuel vehicles, including 8,000 that use compressed natural gas.

Now AT&T has 5,000 compressed natural gas vehicles around the country, and it recently announced it could buy another 1,200 natural gas vehicles in Wentzville, Missouri.

Furthermore, General Motors (NYSE: GM), Chrylser and Ford (NYSE: F) have all said they’ll have natural gas-powered pickup trucks available for retail sale by the end of 2012.

A Big-Time Play on the Natural Gas Rebound

You can see in the futures market that nimble traders are already positioning themselves to profit from these ground shifts and the natural gas rebound.

The spread between October and May natural gas contracts on the NYMEX last month reached a record high $0.481 per million btu. That was around the time that futures slid to $1.902 per million btu – the lowest price since September 2001.

Even now the spread between the June and October contracts is around $0.314, when it was just $0.197 on January 30.

Of course, you have to be careful when making natural gas investments. After all, Chesapeake Energy (NYSE: CHK) is one of the biggest natural gas companies in the country, but it’s hardly a good investment right now.

You could simply play the market with an exchange-traded fund, such as the U.S. Natural Gas Fund (NYSE: UNG). That would give you the upside of natural gas prices, while smoothing out your downside risk.

But if you really want to profit from the natural gas rebound, follow the heed of Louis – he’s been eyeballing a big-time play for the past year and firmly believes that now is the time to pounce.

It’s an up-and-coming play in the burgeoning fracking industry, and the best part is, it pays a 9.3% dividend. That means you’ll be getting a sizeable and steady payout while you wait for the inevitable natural gas rebound.

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