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Natural Gas Price Comeback

Keith Kohl

Written By Keith Kohl

Posted August 18, 2009

It’s been nearly three weeks since I last talked about natural gas.

And lately there really hasn’t been much reason to get excited. Prices have been stagnant at best, right? After all, it was just over a year ago when prices were well over $10 per Mcf. A few weeks ago, prices finally rebounded over $4 per Mcf.

As you’re probably aware, the move didn’t last long.

Today, prices are barely holding above $3/Mcf ($3.16/Mcf the last time I checked). But if there’s one thing we’ve been trying to show Energy and Capital readers, it’s that this is a golden opportunity to get back into natural gas.

Believe me, if natural gas under $4 is a steal, I can’t express how dirt-cheap it is under $3 per Mcf.

But before I get into my long-term bullish sentiment, let’s take a quick look at why prices have declined. To start with, the demand picture has been ugly during this recession.

In their latest Short-Term Energy Outlook, the EIA estimated that natural gas consumption will fall 2.6% this year and remain flat throughout 2010. Of course, the drop is due to the lackluster industrial demand, which makes any future economic recovery even more important to the long-term case.

The supply side of the equation isn’t much better right now. The EIA reported that working gas storage increased to 3,152 Bcf. That’s 530 Bcf above the five-year average of 2,635 Bcf. The five-year storage is nearly 20% higher than a year ago. Furthermore, our working gas storage is expected to top 3,800 Bcf by the time we reach the end of the injection season in October.

In response to the demand drop and cheap prices, companies have drastically scaled back their drilling activity. According to Baker Hughes, there are approximately 688 rigs drilling for natural gas in the U.S. That’s a steep drop of 56% from a year ago.

However, when it comes to natural gas, it’s not the short-term that I’m excited about.

The Bullish Case for Natural Gas

Let’s take a quick look at where our natural gas comes from. . .

According to the EIA, the United States imported approximately 4 Tcf of natural gas in 2008. As expected, nearly all of our imports (approximately 90%), were shipped from Canadian pipelines.

I don’t expect Canada to keep up those numbers for very long.

You see, aside from aside from a few emerging shale deposits, Canadian production isn’t looking too good. Practically all of Canadian natural gas is produced from the Western Canadian Sedimentary Basin. Production in the WSCB, however, peaked back in 2001 at approximately 16 Bcf per day.

Canadian drillers have been struggling to keep up ever since. The only way producers could keep up with the decline rates was by increasing their rig activity. With prices this cheap, it’s nearly impossible to keep pace. Several weeks ago, my colleague, Chris Nelder, pointed out the 11% year-over-year Canadian production decline.

Last week, First-Energy Capital Corp analyst Martin King reiterated the bad news: “At a projected average of 14.7 Bcf per day in 2009, this would be the lowest average natural gas production rate seen in Western Canada since 1995.”

Throw the blame wherever you’d like, dear reader; whether it’s the decreased demand, warm weather, or even the storage glut, the short-term price outlook for natural gas isn’t pretty. However, the dearth of North American drilling from those factors will help prices recover over the long run. Couple the lack of drilling with a demand recovery, and any glut in supply will quickly dissipate.

Depending on an economic recovery, natural gas prices could easily top $6 per Mcf by the end of 2009. That’s certainly not too far of a stretch, considering January 2010 contracts of natural gas are trading around $5.47/Mcf.

I have yet to meet a reader of mine that’s bearish on natural gas over the long term. For us, that means that now is the time to get your hands dirty.

Three Ways to Play a Natural Gas Price Rebound

One of the easiest ways to play a rebound in natural gas prices is through the United States Natural Gas Fund (NYSE: UNG), which tries to replicate the performance of natural gas by investing in the front-month natural gas NYMEX contract.

With UNG trading at a near 52-week low, any upturn in natural gas prices could give investors a pleasant surprise.

By now, anyone who has put so much as a dime in natural gas has at least heard of the latest shale plays. Take Canada’s production woes, mentioned earlier. One of the bright spots on future Canadian gas production is located in the Horn River Basin. The Horn River Shale Formation in British Columbia is one of the more recent shale plays to make headlines — with potentially 250 trillion cubic feet of natural gas in the ground, between 10% and 20% would be recoverable.

However, the producers aren’t the ones that have my attention. Rather, it’s the infrastructure that I’m focusing in on. In order to get the Horn River gas to market, pipelines are needed to transport the natural gas. Several pipeline projects are in the works, including the Pacific Trail Pipelines Limited Partnership. Once completed, the $1.2-billion pipeline will transport Horn River shale gas to an LNG terminal near Kitimat, B.C.

And then we have the individual U.S. shale players.

Even with the 56% decline in drilling from 2008 levels, many of these companies have managed to see production rise. Of course, when it comes to drilling, it’s all about location. Although producing natural gas from these new shale plays isn’t without its own difficulties (extracting the shale gas requires drilling deep into the ground and effectively fracturing the shale), the potential for bullish investors is certainly there.

Once prices finally rebound next year, I believe shale gas production will play a huge role in meeting U.S. demand. The question is whether or not you positioned yourself to take advantage of the comeback.

Until next time,

keith kohl

Keith Kohl

Energy and Capital

Editor’s Note: Although I don’t specifically mention any of these shale companies, I don’t want to leave my readers in the dark. I’ve prepared a new report on one shale play in particular that is breaking the record books. You can find out more about this opportunity here.

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