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Message: Natural Gas: What Is Next? / anyone using long / short ETFs
I did really well trading long / short Nat gas ETFs in the last couple of months, in and out 32 times, may still have some legs, worth a look, same to a smaller extent shorting gold, silver, base metal, MSCI emerging markets, and yesterday Oil (scary) and energy ETF, short term 5 to 10% swings, works for me, for now....
Natural Gas: What Is Next?
By: Dian L. Chu Friday, October 16, 2009 11:02 PM
Unlike oil, which can be transported and traded around the world, natural gas (not in the liquid form) is tough to transport, and thus boxed in within the producing continent. The inventory glut due to diminishing demand since the recession hit in the 4th quarter of 2008 has been pressuring U.S. natural gas prices. As a result, on Sept. 4, the NYMEX October futures contract for natural gas closed at $2.73/mmbtu, a 7-year low, as the ratio of oil to natural gas prices exploded to 25-to-1, compared to its energy conversion ratio of 6-to-1.
Now, just one month later, natural gas has rebounded 75% to close at $4.77/mmbtu for NYMEX November delivery last Friday on record high levels of natural gas in storage, leaving investors to wonder if prices have bottomed out and it's time to jump back into the market, or if the sector is dead.
With the 2010 strip priced around $6.00 on NYMEX, traders clearly are betting that the recent supply/demand trend will lead to falling inventory levels. Is the futures market right about this? Let's review some of the key trends in the U.S. natural gas sector.
No Help from the Fundamentals
During injection season, producers store natural gas to ensure ample supply for the winter when high demand typically normalizes inventory levels. This winter, however, may be difficult as storage levels were at all time highs going into the injection period, production from new shale gas fields still continues to flow (albeit at a slower rate), and a dismal economy dented end user demand, particularly in the industrial and electric power sectors. (Fig.
Now, just one month later, natural gas has rebounded 75% to close at $4.77/mmbtu for NYMEX November delivery last Friday on record high levels of natural gas in storage, leaving investors to wonder if prices have bottomed out and it's time to jump back into the market, or if the sector is dead.
During the past month, several factors have emerged to spur enthusiasm in the futures market, though spot gas continues to suffer in price.
- Generally, macroeconomic forecasts have been upgraded for 2010 on the back of Federal Reserve Chairman Ben Bernanke stating that the recession was "very likely over." This lends itself to a bullish demand outlook for natural gas from the industrial sector.
- The presence of colder weather in early October, notably in the Rockies Mountain region, helped support natural gas prices. The National Weather Service forecast for Oct. 16-22 calls for below-normal temperatures across the Midwest, the mid-Atlantic and parts of the Northeast. The cold temperatures are expected to spur some early heating demand for natural gas.
- Natural gas rig count has dropped more than half from its historical high of 1,606 reached in Sep 2008, implying an improved supply picture fueling bullish price anticipation.
- The rally was also helped by traders and speculators who had sold positions expecting natural gas price to decline, and speculators who were betting against United States Natural Gas Fund LP (UNG). When those bets failed, speculators and traders canceled positions by buying back futures, sending the contract higher.
No Help from the Fundamentals
During injection season, producers store natural gas to ensure ample supply for the winter when high demand typically normalizes inventory levels. This winter, however, may be difficult as storage levels were at all time highs going into the injection period, production from new shale gas fields still continues to flow (albeit at a slower rate), and a dismal economy dented end user demand, particularly in the industrial and electric power sectors. (Fig.
1 & 2) As a result, storage levels could hit maximum capacity of approximately 3.890 trillion cubic feet by the end of the injection season (October 31).
Rig Count Has Declined, Production is Still High
Most investors and analysts tend look at the total number of rigs drilling for natural gas in the U.S. as an indicator for future natural gas supply. However, a better gauge of the natural gas production trend is the horizontal rig count instead of the total gas rig count.
Horizontal rigs are used predominantly in shale gas wells, which typically produce about twice the output of a conventional well on average, and are the primary reason for the surge in natural gas supply during the past few years. While the total gas rig count has fallen 55% from the Sep. 2008 peak, the horizontal rig count has dropped only about 27%, according to data from Baker Hughes, Inc. (BHI). This is part of the reason why natural gas production levels have not dropped proportionally to the decline in the total natural gas rig count.
Lagging Effect from Price to Production
In general, rig counts, and the actual production lag the Henry Hub price by between 6 weeks to 6 months due to the technological complexity of shale gas drilling and production operations, which is another factor for the seemingly slow response from the natural gas production side.
Producers Hedging Positions
Another reason is that some independent gas producers have entered into favorable hedge positions for part of their 2009 and 2010 production. For example, in its 2nd quarter earnings release, Anadarko Petroleum Corp. (APC) said that it has locked in fixed price contracts for 80% of its 3rd quarter 2009 natural gas volumes, and other various hedges on 75% of its 2010 production volume with a middle floor price of $5.60. EOG Resources Inc. (EOG) also has about 47% of its 2nd half 2009 production hedged at $9.03, and 60 mmcfd of its 2010 production hedged at $10.27.
Higher Natural Gas Prices Could Encourage More Drilling
The EIA currently expects the total U.S. marketed natural gas production to increase by 1.5% in 2009 and decline by 3.8% in 2010.
Rig Count Has Declined, Production is Still High
The latest U.S. EIA report shows that marketed natural gas production in the Lower-48 States rose by 2.9% year-over-year through July 2009, despite a more than 40% decline in the working rig count since the start of the year.
Most investors and analysts tend look at the total number of rigs drilling for natural gas in the U.S. as an indicator for future natural gas supply. However, a better gauge of the natural gas production trend is the horizontal rig count instead of the total gas rig count.
Horizontal rigs are used predominantly in shale gas wells, which typically produce about twice the output of a conventional well on average, and are the primary reason for the surge in natural gas supply during the past few years. While the total gas rig count has fallen 55% from the Sep. 2008 peak, the horizontal rig count has dropped only about 27%, according to data from Baker Hughes, Inc. (BHI). This is part of the reason why natural gas production levels have not dropped proportionally to the decline in the total natural gas rig count.
Lagging Effect from Price to Production
In general, rig counts, and the actual production lag the Henry Hub price by between 6 weeks to 6 months due to the technological complexity of shale gas drilling and production operations, which is another factor for the seemingly slow response from the natural gas production side.
Producers Hedging Positions
Another reason is that some independent gas producers have entered into favorable hedge positions for part of their 2009 and 2010 production. For example, in its 2nd quarter earnings release, Anadarko Petroleum Corp. (APC) said that it has locked in fixed price contracts for 80% of its 3rd quarter 2009 natural gas volumes, and other various hedges on 75% of its 2010 production volume with a middle floor price of $5.60. EOG Resources Inc. (EOG) also has about 47% of its 2nd half 2009 production hedged at $9.03, and 60 mmcfd of its 2010 production hedged at $10.27.
Higher Natural Gas Prices Could Encourage More Drilling
The EIA currently expects the total U.S. marketed natural gas production to increase by 1.5% in 2009 and decline by 3.8% in 2010.
This production forecast implies a slight increase of horizontal rig counts to 491 and 509 for years 2009 and 2010 respectively. (Fig 3)
However, most shale gas plays need a natural gas price of about $4.50 or more to be profitable. So, if natural gas prices rebound to the $5-$6 range next year, as predicted by many analysts as well as by the futures market, natural gas drilling and production could increase again before the existing overhang is burned off, as smaller producers need the cashflow, and majors need to meet production guidance.
For instance, Royal Dutch Shell PLC (RDS.A) just announced that it plans to increase natural-gas production in North America. Though gas prices are low now, Shell believes long-term prices will recover, justifying the company's interest.
Demand, Storage & Weather
While the hurricane season will soon pass with no disruptions for the Gulf of Mexico's production, the market's focus is shifting towards winter weather forecasts and storage depletion. Whether winter demand will be enough to normalize supply levels will depend on the weather, production and industrial demand.
On the weather front, the EIA Short-term Energy Outlook currently expects slightly milder weather than last winter which will contribute to lower heating use in many areas. Though there are some signs of economic
improvement, they are yet to translate into a turnaround for natural gas demand from the industrial sector. From all indications, demand for natural gas will likely remain relatively flat, but we should expect a larger decrease on the supply side. This means the market probably will remain unbalanced until the 2nd half of 2010.
Moreover, any upside in prices will likely be offset by a corresponding increase in production by cash-strapped producers. This, coupled with the existing inventory overhang, as well as expanding global capacity shipping liquefied natural gas (LNG) to the U.S. from overseas, could keep gas prices trading with considerable volatility in a range of $3 to $6/mmbtu for the next three or four years.
LNG Holds the Future
It's going to take at least three years, probably 2012 or 2013 before we can expect a marked increase in domestic demand for natural gas, along with the maturing of the global LNG market to gradually transform natural gas from being a regionally determined market to that of an internationally traded commodity along the lines of the crude oil market. Until then, crude oil and natural gas, though similar in their energy generating capability, will likely stay on separate path in terms of market price and trading patterns.
Disclosure: No Positions
However, most shale gas plays need a natural gas price of about $4.50 or more to be profitable. So, if natural gas prices rebound to the $5-$6 range next year, as predicted by many analysts as well as by the futures market, natural gas drilling and production could increase again before the existing overhang is burned off, as smaller producers need the cashflow, and majors need to meet production guidance.
For instance, Royal Dutch Shell PLC (RDS.A) just announced that it plans to increase natural-gas production in North America. Though gas prices are low now, Shell believes long-term prices will recover, justifying the company's interest.
Demand, Storage & Weather
While the hurricane season will soon pass with no disruptions for the Gulf of Mexico's production, the market's focus is shifting towards winter weather forecasts and storage depletion. Whether winter demand will be enough to normalize supply levels will depend on the weather, production and industrial demand.
On the weather front, the EIA Short-term Energy Outlook currently expects slightly milder weather than last winter which will contribute to lower heating use in many areas. Though there are some signs of economic
improvement, they are yet to translate into a turnaround for natural gas demand from the industrial sector. From all indications, demand for natural gas will likely remain relatively flat, but we should expect a larger decrease on the supply side. This means the market probably will remain unbalanced until the 2nd half of 2010. Moreover, any upside in prices will likely be offset by a corresponding increase in production by cash-strapped producers. This, coupled with the existing inventory overhang, as well as expanding global capacity shipping liquefied natural gas (LNG) to the U.S. from overseas, could keep gas prices trading
with considerable volatility in a range of $3 to $6/mmbtu for the next three or four years. LNG Holds the Future
It's going to take at least three years, probably 2012 or 2013 before we can expect a marked increase in domestic demand for natural gas, along with the maturing of the global LNG market to gradually transform natural gas from being a regionally determined market to that of an internationally traded commodity along the lines of the crude oil market. Until then, crude oil and natural gas, though similar in their energy generating capability, will likely stay on separate path in terms of market price and trading patterns.
Disclosure: No Positions
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