If you were in a room of investors this past spring and told
them that natural gas prices would soon stage a stunning rebound,
then you would have been laughed out of the room. After all, the
country was facing a major gas glut that within just a few months
threatened to fill up our nation's energy storage system
completely.
Of further concern back then: though the number of gas rigs in
service had been steadily falling, the remaining rigs that were
still in use were pumping out much more natural gas than geologists
had assumed. Yet thanks to rising demand for gas, especially at
power plants that switch from coal to gas (C2G), prices indeed
firmed up -- spectacularly so.
But unfortunately, investors' minds are still stuck in the past.
The press is filled with reports calling for a big pullback in
natural gas. They cite technical factors such as over-extended
price and the possibility of a decision by power companies to
switch back to coal. Yet for a slew of reasons, gas prices can
extend this gain, perhaps to the $4 or even $5 per thousand cubic
feet (
MCF
) mark by next spring. [Nathan Slaughter, editor of
StreetAuthority's
Scarcity & Real Wealth
newsletter, echoed my sentiment, calling for $4 natural gas by the
end of 2013 in
this article
.]
Here's why...
The C2G switchback?
To suggest that power producers will bail on gas and go back to
coal makes little sense. Even after this run, gas is still cheaper
than coal as a power source. Of course, if gas moves up toward the
$6 per MCF level, then theeconomics switch in favor of coal. That's
why we won't be seeing $7, $8 or $9 natural gas any time soon. Gas
at $5 MCF, however, is still a perfectly comfortable level for
power producers.
The rig count lag
As noted earlier, the number of gas rigs in service has been
falling for several years. In January, I noted
the steady drop in active gas rigs
, suggesting that when the rig count fell to 725, it was time to
start buying natural gas stocks. Thatcall was premature, but by the
time that figure fell toward the 600 mark, a change had begun. At
the start of the third quarter I took
a fresh look
at the natural gas industry, noting that the rig count had fallen
to 534. Then, Nathan Slaughter took another look at the beginning
of this month, when the rig count had fallen to just 454.
By then, what we both predicted had already begun: gas prices
had rebounded 40% off their lows, and they've risen another 30%
since my updated look. If you're keeping score, then you should
know the natural gas rig count stands at 422, according to oil and
gas producer
Baker Hughes (NYSE:
BHI
)
. This is the lowest level in 13 years.
Here's the important point about the rig count... Gas wells are
initially quite productive, but as time passes, production starts
to diminish. So those 422 rigs are collectively bound to produce
less natural gas as time passes.
Of course, the industry won't stand by as production falls.
Expect it to start putting more rigs back into service, though only
enough to offset the supply declines from existing rigs. This
industry isn't historically known for production discipline, but
the recent gas price plunge has finally changed the industry's
"pump at any cost" mantra.
The demand side
With supply likely to remain in check, the demand side of the
equation is moving into the spotlight. And energy experts like
Nathan have rightly noted that our natural gas is so much cheaper
than in places like Japan and Europe, that United States is getting
ready to become an export powerhouse. Much has been written about
Cheniere Energy's (NYSE:
LNG
)
imminent construction of a major liquefied natural gas facility in
Sabine Pass, Louisiana, but a half dozen other firms are moving
forward with plans to construct export facilities along the U.S.
Gulf Coast as well.
And as
TheWall Street Journal
recently noted
, major oil firms might make a similar push in Alaska. Constrained
supply and rising demand are the perfect backdrop for more price
gains.
As noted, Nathan doesn't see gas prices hitting $4 until the end
of 2013. That's the same sentiment of gas traders, who don't expect
prices to reach $4 until October 2013, and don't anticipate a move
to $5 for several years. Yet analysts at Morgan Stanley argue that
the "forward curve is still too cheap." They looked at current
supply and demand trends (even before the export opportunity noted
above) and now say that producers have become almost too
constrained in their output. Assuming these producers don't start
to add a lot of new supply to themarket , then the Morgan Stanley
analysts see natural gas prices hitting $4.80 per MCF by the first
quarter of 2013.
Almost no one else is talking about this right now. No one was
talking about $3.60 gas this past spring, either.
Risks to Consider:
The biggest risk to natural gas prices is a mild U.S. winter,
which was the case a year ago. Forecasters currently anticipate a
typical winter heating season, though you need to keep monitoring
these forecasts if you own gas stocks.
Action to Take -->
If these analysts are correct, then investors stand to make big
gains. We've
already noted
that natural gas producers have recently lagged rising natural gas
prices, but don't expect that to last for long. With natural gas
prices expected to continue rising, expect natural gas producers to
make up for lost ground in short order. Below are some of my
favorites...
-
Ultra Petroleum (NYSE:
UPL
)
, one of Nathan's
Scarcity & Real Wealth
holdings, actually generates 90% of its revenue from natural gas,
not petroleum.
-
Southwestern Energy (NYSE:
SWN
)
, one of the lowest-cost gas producers, and with 99% of its
production tied to gas, brings ampleleverage to rising gas
prices.
-
Marathon Oil (NYSE:
MRO
)
, which has underperformed the peer group during the past six
months on concerns that its acreage in the Eagle Ford Shale won't
be as productive as rivals such as
EOG Resources (NYSE:
EOG
)
. But management insists that early production results are coming
in much better than industry analysts are
anticipating.
[
Note
: Natural gas isn't the only opportunity Nathan is finding in
thecommodity market right now. In fact, Nathan has his eye on a
situation in Russia
that could dry up as much as 10% of America's electricity supply.
As the country scrambles to react, a small group of stocks could
soar. And all of this could happen as soon as early 2013. For more
information on the potential crisis, and how toprofit ,
follow this link
.]
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of UPL, MRO in one or more if its "real money"
portfolios.