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Future of Natural Gas Prices

The Inevitable Crunch in Natural Gas Supply... and How to Prepare Your Portfolio

Written by Keith Kohl
Posted March 26, 2009

People haven't paid much attention to natural gas prices this year.

Can you really blame them? It's true that oil prices have been stealing the spotlight lately. Recently, crude prices broke over $54 per barrel. It's been a quite some time since we've last seen those price levels.

Meanwhile, natural gas has been treading water. After deteriorating more than 70% since July records, prices have fallen below $4/Mcf this week. That's a level many people thought they'd never see. And to make matters worse, I've been hearing more and more people calling for natural gas to plummet below $2/Mcf and stay in that range for several months.

I wouldn't hold your breath on that one.

However, it does beg the question of where natural gas will go from here. At least, that's been a recurring theme among the questions I've received from readers.

Personally, I think it's difficult not to have a strong long term outlook for natural gas prices. But before I get into the reasons why a future supply crunch is inevitable, let's take a glimpse at how prices have fallen so much.

As you know, 2008 was a very strong year for production. Of course, that is mostly due to unconventional sources like shale. Onshore production jumped more than 9%. Things were looking very bright.

That is, until everything hit the fan.

The economic crisis took a drastic toll on demand and helped crush natural gas prices, even despite the fourth most active hurricane season since 1944. Prices continued to fall while nearly all natural gas production was shut-in. Since then, natural gas prices have been steadily declining.

The Supply Road Ahead: Glut or Crunch?

Even though 2008 turned out to be quite a year for supply growth in the North American gas markets, a future supply crunch is inevitable.

Developing those shale sources will be extremely difficult (or even nonexistent) if natural gas prices fall below $2/Mcf for a sustained period. The depreciation of natural gas prices since July has already caused companies across the board to slash exploration and production spending.

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Much like the oil industry, not a week passes that I don't see another project being delayed or canceled. Furthermore, the number of active drilling rigs has been in serious decline. The latest numbers from Baker Hughes Inc. reported that the number of exploration rigs has dropped nearly 45%. And if prices continue to remain this low, you can bet we'll see even more rigs going silent.

That means production is headed one way—much lower.

Don't be surprised when you see a good number of changes in upcoming production forecasts. According to the EIA's latest Short Term Energy Outlook, U.S. production is projected to stay flat this year, followed by an 0.8% decline in 2010.

In other words, the supply glut created by those unconventional plays is going dry up when the economy picks back up. And when that happens, all of those delayed projects and cuts to spending will make supplies even tighter.

Now let's add liquefied natural gas on top of all that.

Most of my readers know that LNG isn't on the top of my list. The primary reason I've stayed away LNG investments was the attractiveness of our unconventional gas deposits. I was right on target, too. LNG imports to the U.S. dropped by 54% last year compared to 2007. And to be honest, my sentiment hasn't changed much.

However, I should note that any increases in LNG imports this summer to the U.S. will certainly push our supply crunch back and deteriorate prices further. I don't expect LNG imports to rise over 400 billion cubic feet this year.

The good news is that things will eventually get better for natural gas prices. Of course, the hard part is figuring out when.

Natural Gas Prices: What's Next?

The answer will likely depend on how long this economic turmoil lasts.

Most of the predictions that come across my desk pinpoint the latter half of 2009 as to when we'll pull ourselves out of this economic slump, with things improving even more in 2010.

That makes sense, especially considering the role natural gas plays in our industrial demand.

Until that economic recovery happens, there's not much pushing prices higher. Once that happens, the question will be focused on how much the market remains oversupplied and how soon that excess will dry up.

Investing in Natural Gas Today

It's hard not to stick with the winners.

Now, my regular readers know which natural gas stocks I've had my eye on throughout this market crash. Particularly, I tend to favor companies that are drilling in those prospective areas.

One of those plays I've discussed before was EOG Resources (NYSE: EOG). Even despite the production problems plaguing the oil and natural gas industry, EOG still expects to raise production by 3% this year.

As I've said before, these guys have dipped their hand in nearly every major area I've covered, including the Barnett, Haynesville and Marcellus shale plays (not to mention the Bakken play). Once our economic troubles pass, I wouldn't be surprised to hear about my readers making a fortune off some these types of plays.

Until next time,

keith kohl

Keith Kohl

Energy and Capital

P.S. For those of you who share our long-term bullish outlook for the energy markets, you're not alone. My colleague Ian Cooper has taken this market by the horns, putting up double-digit gains in the blink of an eye. If you would like to see exactly what I'm talking about, I highly suggest checking out the Pure Energy Trader.

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