Careful what you wish for. That's the hard-learned lesson
gleaned by investors and industry executives seeking their fortune
in natural gas. Just a few years ago, they wished to find more
natural gas in the ground and under the sea bed. They did, hitting
mother lode after mother lode. Now, we're awash in natural gas and
a glut has led to a sharp slump in prices.
Could that slump be coming to an end? A host of factors are lining
up to help boost demand and possibly curtail supply of this
relatively clean burning energy source.
If you live in the Northeastern United States, then you can already
guess what Factor No. 1 is. Furnace-like conditions are leading to
a sharp spike in electricity usage. Several long-term weather
forecasting services predict temperatures will stay above average
clear through the end of August. If that's the case, the amount of
natural gas in storage could start to come down quickly and that
should start to provide a tangible lift to prices.
Factor No. 2 relies on the "bath-like" conditions of water
temperatures in the Gulf of Mexico. Meteorologists have noted a
strong correlation between water temperatures in the Gulf and
strong hurricanes. And based on that, they think that we'll be in
for a doozy of a hurricane season. The peak of storm activity is
expected to begin in a few weeks and last into October.
Recall that in 2005, hurricanes Katrina and Rita caused natural gas
prices to soar, as a good deal of production was taken off-line.
The Department of Energy estimates a median 166 billion cubic feet
of gas production could be lost during the 2010 hurricane season --
nearly three days of domestic supply.
Factor No. 3 is more of a wildcard: the Obama administration has
disappointed industry watchers for failing to provide a greater
boost to natural gas-powered vehicles. But the industry isn't
waiting around.
Honda (NYSE:
HMC
)
already sells natural gas vehicles, Fiat has announced plans to do
the same with the next generation of Chrysler cars and trucks, and
major fleet operators such as
UPS (NYSE:
UPS
)
,
FedEx (NYSE:
FDX
)
and
AT&T (NYSE:
T
)
are quickly converting hundreds of vehicles to run on natural gas.
Where will they fill up?
Clean Energy Fuels Corp. (Nasdaq:
CLNE
)
is building natural gas fueling stations. If natural gas can secure
a reliable role as a transportation energy source, then prices
would likely find a floor solidly above current levels.
Supply restraint
For natural gas producers, a re-balancing of supply and demand
can't come fast enough. Even though they were sitting on
newly-discovered massive energy fields, they steadily throttled
back production in a bid to keep a lid on supply. Trouble is,
demand also dropped, and many of the natural gas fields that did
come online produced a lot more gas than expected. But it's only a
matter of time before the restraint pays off. Natural gas fields
have a finite shelf life and eventually yield smaller and smaller
amounts of gas. As older wells get depleted, total output should
drop, allowing prices to rise back up.
You get a sense of the anticipated supply and demand trends by
looking at
futures
prices. Contracts for delivery of natural gas that expire in August
have already risen from around $4.15 per thousand cubic feet to a
recent $4.81. Looking out 18 months to January 2012, those same
contracts go for around $6. Current prices likely account for
Factor No.1 noted above (warming summer weather), but if the second
and third factors cited above come into play, natural gas futures
contracts could quickly move toward the $8 mark.
Action to Take -->
There are a host of ways to play the resurgent natural gas sector.
The
U.S. Natural Gas Fund (NYSE:
UNG
)
, at a recent $8, is up roughly $1 from the spring, yet nowhere
near the $60 levels seen just a few years ago when natural gas was
trading in double-digits.
Or you could buy a basket of natural gas plays through the
First Trust ISE-Revere Natural Gas Fund (NYSE:
FCG
)
. The
index fund
carries fees of up to 0.60% and concentrates on firms that are
mostly exposed to natural gas prices.
A number of energy firms have exposure to both and oil and gas, and
would not rally as sharply in an environment of natural gas prices.
For investors looking for high reward with high risk, can check out
Chesapeake Energy (NYSE:
CHK
)
. Chesapeake employs a hefty amount of debt
leverage
, which really hurt the company when gas prices slumped, but would
magnify earnings if prices were to rise.
-- David Sterman
David Sterman has worked as an investment analyst for nearly two
decades. Most recently, he served as Managing Editor of
RealMoney.com, the premium website of TheStreet.com. David has made
numerous media appearances over the years, primarily on CNBC and
Bloomberg TV, and has a master's degree in management from Georgia
Tech. Read More...
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
StreetAuthority