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Buy Natural Gas Producers To Play The Dramatic Rally in Natgas Prices

Category: Energy & Environment,Finance

Natural gas prices spiked in early trading Monday, with the front-month December contract hitting $3.54 per million British Thermal Units (MMBTU.)  The December and January contracts are both trading above $3.50 and then there is a steep drop off as the curve moves into 2019, and that exposes the true nature of natgas futures trading.  It's all about the present, or the very near-term, anyway. Analysis of crude oil futures entails an incredibly complex and detailed analysis from an army of often long-winded pundits bloviating about global trade patterns, geopolitics and micro issues in countries that most Americans will never visit.

Natgas pricing analysis is much more simple: will we have enough for the winter?

As it stands today, it looks like that answer is "no," especially in the Northeast.  This week I am buying natgas stocks Range Resources, Antero Resources, EQT Resources and EOG Resources to benefit from the supply-demand discrepancy.  This is a trading call, not a long-term buy-and-hold call, but the near-term fundamentals for natural gas pricing look more bullish than at any time is the past four years, and that will directly benefit those commodity producers.

Worker in the oilfield

The front-month natural gas futures contract price has risen 20% since mid-September.  The natgas futures contract is un-affectionately known as the widowmaker among energy traders owing to its history of extreme volatility, but in the past six weeks the contract has shown very little volatility.  It has registered regular price gains, and the explanation is shown in the Energy Information Administration's weekly "working natural gas in underground storage" report.

As of last week, natgas inventories were more than 600 million cubic feet below their year-ago level, a 16.5% decrease.  One cubic foot of gas equals one BTU, so MMBTU and MMCF are used interchangeably to describe natural gas volumes. The decrement versus the five-year average for this time of year was actually slightly higher at 16.9%.  That is a huge stagger to be made up, and now all eyes turn to the weather forecasts, because unseasonably cold weather would send those already below-trend inventory into danger levels.

As with oil prices, natural gas prices are quoted nationally based on the price prevailing at a specific regional distribution point.  In the case of gas the benchmark is used is the Henry Hub in Louisiana. As with any other commodity, natgas is valued when needed, though, and due to the excited state of gas molecules it takes tremendous amounts of space to hold gas so it is much harder to store than oil.

So, natgas pricing is much more sensitive to local demand than oil pricing is, and gas transport contracts into major urban centers are based on what is called "citygate" pricing.  It's as if there is a huge gas bubble that is held in abeyance on the outskirts of New York City, only to be released when the price clears the market. Of course it doesn't work that way in reality, but citygate prices do vary widely by region.  In the last reported EIA data point, for example, natgas prices in gas-producing Ohio stood at $2.86/MMCF while prices in New York, where Governor Cuomo has banned gas drilling, stood at $8.49/MMCF. It is not all politics, either, as Massachusetts, which has no significant explored natgas reserves, posted a citygate price of $10.96/MMCF in that data point.

Energy products are needed where and when they are needed, and that rarely jibes with where they are produced.

The EIA has reported lower than average natural gas inventory in every monthly report in 2018, and yet the natgas futures price has only started to jump above $3.00/MMCF in the past six weeks.  The industry entered the 2017 winter heating season with inventories at average levels, and the drawdown last winter was within historical levels. The spring injection session failed to return inventory to average levels, though, and the summer saw the inventory level fall out of the five year average range, setting the stage for this fall's rally in prices.

Why isn’t the U.S. producing enough natural gas to fill demand?  Natgas prices have been depressed for years and haven't sustainably held the $3/MMCF mark since mid-2014.  The oil crash after OPEC's disastrous Thanksgiving 2014 meeting didn't help, either, as natgas is often a by-product of crude oil production.  Thus, natgas producers significantly lowered drilling expenditures in the 2015-2017 period, and those undrilled wells are being realized as unproduced natural gas today.  

The producers that can quickly move the needle--the marginal producers in industry parlance--are the gas-focused companies, not the major integrated multinationals like Exxon Mobil and BP.  Those smaller, more nimble natural gas producers will benefit hugely from this spike in natural gas prices.

I believe the highest gas yields and the most capital-efficient incremental production lies in the Marcellus/Utica region in Pennsylvania, West Virginia and Ohio.  Producers there also benefit from being closer to the Northeast's major population centers.

Shouldn't the stocks of natgas producers have moved upward in anticipation of October’s jump in natgas pricing?  Well, the stock market has flirted with correction in the past two months and energy stocks have been particularly hard hit owing to the recent decline in crude oil prices.  Again, though, the natgas futures contract is known as the widowmaker for a reason, and this subsector offers the rare chance to participate in market that--even in the age of AI and machine learning--can and often does experience surprise.

So, to play the natural gas renaissance, I recommend playing the Marcellus/Utica blue chips.  Yes this is a trading call, but just getting these names back to their early-September levels would bring you ~20% profits.  Seeing the benefit from an entire winter of elevated natgas pricing (which I believe is in the offing,) would offer much more attractive returns than that.  All of these names are trading at least 50% below their 2014 highs, and while I don't think the individual names will make up that stagger this winter (which, mathematically, would require them to double) I see strong gains ahead in an overall stock market that seems tired and deathly afraid of inflation.  

Higher natural gas prices contribute to inflation, especially in the winter, so you should make sure your portfolio benefits by including shares of natural gas producers.  

Range Resources: NYSE:RRC

Antero Resources:  NYSE:AR

EOG Resources:  NYSE:EOG

EQT Resources:  NYSE:EQT

 

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Natural gas prices spiked in early trading Monday, with the front-month December contract hitting $3.54 per million British Thermal Units (MMBTU.)  The December and January contracts are both trading above $3.50 and then there is a steep drop off as the curve moves into 2019, and that exposes the true nature of natgas futures trading.  It's all about the present, or the very near-term, anyway. Analysis of crude oil futures entails an incredibly complex and detailed analysis from an army of often long-winded pundits bloviating about global trade patterns, geopolitics and micro issues in countries that most Americans will never visit.

Natgas pricing analysis is much more simple: will we have enough for the winter?

As it stands today, it looks like that answer is "no," especially in the Northeast.  This week I am buying natgas stocks Range Resources, Antero Resources, EQT Resources and EOG Resources to benefit from the supply-demand discrepancy.  This is a trading call, not a long-term buy-and-hold call, but the near-term fundamentals for natural gas pricing look more bullish than at any time is the past four years, and that will directly benefit those commodity producers.

The front-month natural gas futures contract price has risen 20% since mid-September.  The natgas futures contract is un-affectionately known as the widowmaker among energy traders owing to its history of extreme volatility, but in the past six weeks the contract has shown very little volatility.  It has registered regular price gains, and the explanation is shown in the Energy Information Administration's weekly "working natural gas in underground storage" report.

As of last week, natgas inventories were more than 600 million cubic feet below their year-ago level, a 16.5% decrease.  One cubic foot of gas equals one BTU, so MMBTU and MMCF are used interchangeably to describe natural gas volumes. The decrement versus the five-year average for this time of year was actually slightly higher at 16.9%.  That is a huge stagger to be made up, and now all eyes turn to the weather forecasts, because unseasonably cold weather would send those already below-trend inventory into danger levels.

As with oil prices, natural gas prices are quoted nationally based on the price prevailing at a specific regional distribution point.  In the case of gas the benchmark is used is the Henry Hub in Louisiana. As with any other commodity, natgas is valued when needed, though, and due to the excited state of gas molecules it takes tremendous amounts of space to hold gas so it is much harder to store than oil.

So, natgas pricing is much more sensitive to local demand than oil pricing is, and gas transport contracts into major urban centers are based on what is called "citygate" pricing.  It's as if there is a huge gas bubble that is held in abeyance on the outskirts of New York City, only to be released when the price clears the market. Of course it doesn't work that way in reality, but citygate prices do vary widely by region.  In the last reported EIA data point, for example, natgas prices in gas-producing Ohio stood at $2.86/MMCF while prices in New York, where Governor Cuomo has banned gas drilling, stood at $8.49/MMCF. It is not all politics, either, as Massachusetts, which has no significant explored natgas reserves, posted a citygate price of $10.96/MMCF in that data point.

Energy products are needed where and when they are needed, and that rarely jibes with where they are produced.

The EIA has reported lower than average natural gas inventory in every monthly report in 2018, and yet the natgas futures price has only started to jump above $3.00/MMCF in the past six weeks.  The industry entered the 2017 winter heating season with inventories at average levels, and the drawdown last winter was within historical levels. The spring injection session failed to return inventory to average levels, though, and the summer saw the inventory level fall out of the five year average range, setting the stage for this fall's rally in prices.

Why isn’t the U.S. producing enough natural gas to fill demand?  Natgas prices have been depressed for years and haven't sustainably held the $3/MMCF mark since mid-2014.  The oil crash after OPEC's disastrous Thanksgiving 2014 meeting didn't help, either, as natgas is often a by-product of crude oil production.  Thus, natgas producers significantly lowered drilling expenditures in the 2015-2017 period, and those undrilled wells are being realized as unproduced natural gas today.  

The producers that can quickly move the needle--the marginal producers in industry parlance--are the gas-focused companies, not the major integrated multinationals like Exxon Mobil and BP.  Those smaller, more nimble natural gas producers will benefit hugely from this spike in natural gas prices.

I believe the highest gas yields and the most capital-efficient incremental production lies in the Marcellus/Utica region in Pennsylvania, West Virginia and Ohio.  Producers there also benefit from being closer to the Northeast's major population centers.

Shouldn't the stocks of natgas producers have moved upward in anticipation of October’s jump in natgas pricing?  Well, the stock market has flirted with correction in the past two months and energy stocks have been particularly hard hit owing to the recent decline in crude oil prices.  Again, though, the natgas futures contract is known as the widowmaker for a reason, and this subsector offers the rare chance to participate in market that--even in the age of AI and machine learning--can and often does experience surprise.

So, to play the natural gas renaissance, I recommend playing the Marcellus/Utica blue chips.  Yes this is a trading call, but just getting these names back to their early-September levels would bring you ~20% profits.  Seeing the benefit from an entire winter of elevated natgas pricing (which I believe is in the offing,) would offer much more attractive returns than that.  All of these names are trading at least 50% below their 2014 highs, and while I don't think the individual names will make up that stagger this winter (which, mathematically, would require them to double) I see strong gains ahead in an overall stock market that seems tired and deathly afraid of inflation.  

Higher natural gas prices contribute to inflation, especially in the winter, so you should make sure your portfolio benefits by including shares of natural gas producers.  

Range Resources: NYSE:RRC

Antero Resources:  NYSE:AR

EOG Resources:  NYSE:EOG

EQT Resources:  NYSE:EQT

 


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