A Bull on Natural Gas

Henry Groppe , the octogenarian patriarch of Texas petroleum industry analysts Groppe Long & Littell, goes contrarian again. This time, he predicts that natural gas will trade above $8 by September 2010.

(…)  his analysis (and more than 50 years of experience) tells him that gas inventories are about to get a lot tighter, that new supplies are overstated, and that prices are headed north of $8 by the end of summer.(…)

“There are very optimistic estimates about the economically recoverable volumes of shale gas” he said in an interview last week (…).

The reality, he argues, is that shale gas deposits are a tiny part of the North American production pool – and they are already depleting fast.

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While the shortcomings of ETFs that track commodities have been well documented, the discrepancy between the price of natural gas and the ETF that is meant to track its price provides a great reminder of why many of these more exotic vehicles should be avoided.  As always, investors should know what they own and look into these vehicles before investing in them.

The chart below compares the YTD performance of the front month natural gas futures contract and the United States Natural Gas Fund (UNG).  Through the end of August, natural gas and UNG were both down similar amounts and had tracked each other relatively closely.  Since then, however, natural gas has made a major reversal and is actually up on the year.  UNG, on the other hand, remains down over 55%.  In essence, UNG holders have missed out on the entire rally.

While the explosion in popularity of ETFs has had many positive effects and created numerous efficiencies for investors, the boom in the industry hasn’t been void of some individual busts.

Natural Gas ETF

Bespoke Investment


Is Nymex natgas the ‘Yugo’ of the the energy complex?

…according to Stephen Schork, the analyst behind the widely-read Schork report on energy markets, it certainly is. In fact, he provides the following illustration of the communist-era car in his Monday report to emphasise the point:
As Schork points out, if spot gas can go from 2.409 to 5.318 — with no discernible fundamentals backing such a move — then there’s no reason it can’t go back to 2.409.

This is especially so given that natgas has been retreating gradually lower over the course of the last two weeks — which proved to be one of the coldest Octobers on record in the US:

Nymex Natgas - FT

In short, natgas — traditionally one of the most responsive commodity markets to supply and demand fundamentals — has been acting hugely out of character.

So is this a sign the natgas bubble might be popping? Schork suggests it might be, reminding us that when bubbles pop they tend to crash more quickly than the pace at which they inflated (our emphasis):

Unfortunately, bubbles can usually outlast your line of credit. Once bubbles pop however, they tend to not only retrace to whence they began, but more importantly, overshoot this area. That is the point we are at right now in the Henry Hub gas market.
For example, in August 2007 spot crude oil was at $75 a barrel. That was right at the time everyone was becoming keenly knowledgeable on the definition of subprime. Knowing how bad the coming storm was going to be, the Fed telegraphed to the market that September its intention to take nearby rates to zero.
That in turn set the dollar into a freefall and commodity speculators into a buying frenzy. But with all of that said, it took the market 10 months, from September 2007 to July 2008 to push price from $75 to $150. In the subsequent post bubble correction, it took the market only 3 months (until mid October 2008) to push spot oil back down to $75. It then took the market only two more months after that (until mid December) to push crude oil down by more than 50%, from where the bubble started at $75, down into the low $30s.
Therefore, we cannot rule out further corrective weakness in spot NYMEX gas back towards the mid $2 area we saw in late August, early September. However, first things first, there is a large gap (on the continuous chart) in between the October 28th low at 4.230 and the September 25th high print at 4.035. If the bulls cannot protect this gap, we will indeed look for significant weakness below here.

We’ll be watching.

FT Alphaville

And from the WSJ:

Almost half the exploration and production (E&P;) companies followed by Deutsche Bank analyst Shannon Nome raised forecasts for 2009 production.(…)

The natural-gas rig count, an indicator of drilling activity, bottomed in mid-July and has since climbed 10%, according to Baker Hughes. The number of operating "horizontal" rigs, used in the more-prolific gas shale fields, has jumped 28%.

With producers still collectively pursuing growth, the chances of a rebound in gas prices next year looks more remote than ever. Yet the S&P; Supercomposite oil and gas E&P; index—weighted 69% to gas production—commands a forward price/earnings multiple of 22 times. Such confidence is the very thing causing the industry to drill its way into trouble.

What many people forgot to consider when nat gas prices hit the floor last summer is the importance that auto and chemicals production has on gas demand (see my Aug 9, 2009 post NATURAL GAS STILL DISCOUNTING THE OVERHANG). demand from these two industrial sources strengthened during the summer months but …

… shipments of chemicals have weakened since, …



… and motor vehicles could be peaking at a low level in the aftermath of the cash-for-clunker program.


Charts from the Association of American Railroads



Car assembly plants have been restarted and weather has been quite warm, yet storage is of the chart>

               Working Gas in Underground Storage Compared with 5-Year Range

Working Gas in Underground Storage Compared with 5-Year Range

Note: The shaded area indicates the range between the historical minimum and maximum values for the weekly series from 2004 through 2008.
Source: Form EIA-912, "Weekly Underground Natural Gas Storage Report." The dashed vertical lines indicate current and year-ago weekly periods.

From The Globe and Mail:

In Calgary, after more than a year of falling prices, gas producers have been girding themselves for this – partly by slashing spending on new wells and, increasingly, by turning off the tap on existing ones to wait for better prices.

The number of rigs drilling for gas in the United States is down by more than 50 per cent. In Canada, the decline is close to two-thirds.

“We have no rigs running whatsoever,” said Brian McLachlan, chief executive officer of junior explorer Yoho Resources Inc.(…)

Companies that are still drilling are connecting new wells to pipelines but not turning on production until prices are higher. Others, like industry leader EnCana Corp., are capping existing wells until prices rebound.

And from Dennis Gartman:

Nat-gas, on the other hand, just keep deteriorating as the fundamentals seem relentlessly bearish. Once again, we’ll counsel that those who believe they must “punt” bullishly of nat-gas simply because it looks cheap and they cannot help themselves that they sit down, take a very deep breath and note that the contango is so severe that they’ll pay 70% more for nat-gas for delivery in January than they shall for nat-gas deliverable in September. A bullish bet
upon nat-gas given this massive contango is the worst of mug’s games.

However, if you must, at least make the bet in the nat-gas trusts, for at least there one is paid to own the position where in the futures one pays for admission via this massive contango [Ed. Note: We can recall not so long ago when we thought nat-gas was “cheap” relative to Crude when the crude/Nat-gas price ratio was 12:1. We admitted error and exited the trade when it moved to 13;1 and we stood astonished as it moved to 15:1 and then 18;1 and then 20:1. Friends and clients told us we needed to return to the trade and we said that the trend was still against natgas and for crude and that we’d wait a while longer before venturing back in. As we write this morning the
ratio is now out to 24.2:1. Any takers here?]


Natural Gas Falls to Seven-Year Low

Natural-gas futures fell to a fresh seven-year low as a glut of the fuel and tepid demand outweighed diminishing concerns about storms in the Atlantic.

Natural gas for September delivery on the New York Mercantile Exchange fell 6.7 cents, or 2.1%, to settle at $3.096 a million British thermal units.

That represents the lowest settlement since Aug. 14, 2002, and marks the ninth consecutive trading day of declines in gas futures.

Gas prices slid as computer models indicated Hurricane Bill, the Atlantic season’s first, would steer clear of energy infrastructure in the Gulf of Mexico, while the remnants of Tropical Storm Ana dissipated.

"We’re oversupplied, and these storms aren’t causing a disruption," said Mike Rose, head of the energy trading desk at Angus Jackson Inc. in Fort Lauderdale, Fla.

The continued declines, even in the midst of hurricane season, underscore how booming onshore domestic gas production has led to an overabundance of the fuel, resulting in a market that relies less on Gulf output.

In recent years, when the Gulf represented a fifth of the U.S. gas production and markets were strained, any threat of storms could send prices soaring. But gas output from the Gulf now accounts for about 11% of domestic supply as producers have increasingly moved on shore to tap gas-rich formations known as shales, putting less supply in the path of storms and boosting overall output from these new fields.

Full WSJ article



The price of natural gas is currently as low vs oil than in early 1990 owing to the combination of higher production with collapsing industrial demand. Production will be negatively impacted by low prices but demand is the key. Production restart at car manufacturers and chemical companies should boost demand in the next 6-12 months, especially since switchers will no doubt turn the knob to NG.




Source Cornerstone Analytics


Two Traders Will Urge Changes in Gas Market

A former Enron trader who is one of the energy markets’ largest speculators plans to make a surprising recommendation to commodities regulators: rein in the ability of traders like him to influence prices.

John Arnold, head of the $5 billion hedge fund Centaurus Advisors, is expected to argue before the Commodity Futures Trading Commission on Wednesday that trading should be limited in the benchmark natural-gas futures contract at certain points on the New York Mercantile Exchange because in-and-out activity can distort the underlying or "physical" gas price.

Speculators invest in commodities for financial reasons and don’t take physical delivery. Critics say speculators magnify price swings; supporters say they help markets function.

In other testimony, Michael Masters, a hedge-fund manager and commodity-speculation critic, will suggest broader restrictions on oil and gas investing — including banning investors such as pension funds from trading in major oil and natural-gas futures.(…)

Mr. Arnold is expected to suggest that, when futures approach expiration, most trades should be made on platforms that allow purely financial bets on the direction of gas, and are settled in cash instead of making or taking delivery of actual fuel.

"There is no reason why a hedger or a speculator needs to trade physical delivery contracts if financially settled contracts are available at the same price," he contends in testimony.(…)

He is expected to argue that Nymex erred in June when it said it will limit traders’ positions in financially settled gas contracts. He advocates dropping those limits because they would trim energy firms’ ability to lock in the best price for future energy production with trading counterparties like Centaurus.

He also is expected to ask the CFTC to impose stiffer trading limits on the Nymex contract that can be settled with physical delivery. He says Nymex’s current system of limits to that contract as it approaches expiration has created the "potential for abuse" by letting traders make bets with little monitoring.

Meantime, Mr. Masters is expected to testify that "passive investors" with no physical stake in the underlying commodity should be banned from trading. Such passive investors hold and roll a position in a single commodity or in a vehicle designed to duplicate an index of multiple commodities, such as the S&P-Goldman; Sachs Commodity Index.

Passive investors compete with physical commodity consumers and make it harder for them to hedge, Mr. Masters plans to testify. Their activity, he argues, obscures the natural price. Goldman executives object to suggestions the index distorts prices.

Mr. Masters also will call on swaps dealers to report positions of trading partners on the other side of transactions. Swaps dealers object. "Fundamentals of supply and demand drive these markets," says Robert Pickel, chief executive of the International Swaps and Derivatives Association, who also testifies Wednesday. "There is a role of speculators to supply depth and liquidity. That is a good thing."

Full WSJ article