Profit from Surprising Strength in Natural Gas
While most attention remains fixed on sluggish crude oil prices, natural gas has been moving up. It is currently trading at $4.80 per 1,000 cubic feet (or million BTUs), which is the standard NYMEX futures contract.
My estimate of the average price for 2011 has been $4.20, rising to about $4.65 in 2012.
Might be time to revisit those figures…
With significant excess supply available, gas storage levels returning to levels of the past three years, and the slow economic recovery continuing to keep significant demand (mainly industrial) off the market, many are wondering – why is the price of natural gas going up?
Not too long ago, the prevalent opinion among analysts was that the supply glut would restrain prices for some time. A few were even predicting average prices for the year would stay well below $4.
So let's talk about what happened… and what it means for investors.
A Pricing Floor Has Emerged
Let's first put things in perspective: In the U.S., we are not going back up to the $13 prices experienced in 2008. But the market does seem to be telling us that the price is not going to take a dive, either.
Indeed, a combination of factors is emerging to provide a floor for prices moving forward.
And that is very good news for investors. Because, given the huge amounts of unconventional gas coming into the market from shale, coal bed methane, and tight gas plays in North America, pricing is the primary consideration in end usage.
Unlike with oil, natural gas has a known pricing range, putting some cap on volatility. That, in turn, opens up a number of investment opportunities in both the production of natural gas and its primary uses.
Meanwhile, demand projections elsewhere in the world are increasing faster than anticipated. The International Energy Agency (IEA) recently reported that gas demand would rise by 50% by 2035, to amount to one-quarter of all global energy use.
That's partly due to a major shift away from coal in some regions – although accelerating electricity requirements mean usage of both gas and coal will continue to expand.
The rise in natural gas prices, however, will hit other parts of the world more severely than North America. Europe, for example, is facing a major price hike in volume imported from Russia – to $500 per 1,000 cubic meters before the end of the year. (That's equivalent to a NYMEX contract price of more than $14!)
One thing is certain: Global demand is increasing.
Some of this is due to major industrial advances in developing countries; some comes from the nations, like Germany, that decide to phase out nuclear energy. Still another emphasis is arising from the improvement of aggregate per capita income and the consequent boomin
g consumer demand for energy.
In some places, this strong demand, combined with the increasing transit of liquefied natural gas (LNG), is making for a rapidly developing environment in which pricing differences between markets is becoming of major interest to arbitrage investors.
We are still a few years away from genuine spot (immediate delivery) markets in major regions setting the overall price.
Nonetheless, the opening later this year of Rotterdam Gate – the world's largest LNG receiving facility – has already developed a northern European spot market to compete with volume coming in via pipeline from Russia and Norway.
Back in the U.S., the price improvement results from three major factors.
First, we are beginning to see a greater balance between production and end-use applications. That is allowing a better utilization of pipeline capacity for both storage and transport, while at the same time reducing E&P (exploration and production) costs.
Second, weather projections indicate this is going to be one hot summer – both in North America and in Europe. This means greater electricity generation and a corresponding rise in gas needs.
But the third reason is the most important.
Even without a rapid move to natural gas-fueled transportation, the move in the U.S. for electricity production is away from coal and into gas. The transition has been supercharged by new power-generating emission regulations that attack coal as a fuel source. (See “Two Non-Carbon Regulations About to Rock the Coal Sector,” October 29, 2010.)
Coal, of course, will remain in use, but its percentage of the energy mix will decline. Not a single new coal or co-fueled (coal and gas) power plant is planned anywhere in the country.
As the rise in electricity demand continues, renewables (solar, wind, geothermal) and natural gas will be the primary beneficiaries.
There may well be an increase of 20% to 25% in the use of gas as a fuel for electricity within the next decade alone.
And that's great news for the U.S.
We now know we have a huge amount of it at an affordable cost. And, unlike with oil, there is no concern that rising natural gas prices will cut into booming demand.