Now is the time to buy natural gas
I was thinking about commodities this morning and I decided that now is the time to buy natural gas. Here is how I came to this conclusion.
Natural gas has been an absolute mess over the past year. The price of nat gas has absolutely collapsed from over $13 last summer to less than $4.00 today. After a recent head fake to slightly over $4.00 natural gas closed yesterday at $3.64.
There are several reasons why the price of natural gas fell so precipitously, including the strengthening of the U.S. dollar, but the main reason is that the number of rigs drilling for it skyrocketed when prices were high and the current recession caused industrial usage of nat gas to fall. Economics 101 dictates that high supply of and low demand for a commodity creates low prices. The supply of natural gas is still sits at the top of its five year average range:
This chart may lead one to ask "If the amount of gas in storage is so high, then why are you so bullish on it?" The answer is help is on the way in the form of fewer rigs actively drilling for gas. The time to buy nat gas and E&P companies that have significant exposure to it is when prices are low.
This collapse in the price gas has been absolutely disastrous for drillers. According to Baker Hughes, after peaking at 1,600 in September of 2008 the number of active natural gas rigs in the United States is now only to 782, down over 50% versus the same period a year ago. The number of rigs drilling for nat gas in the U.S. is now sitting at a six and a half year low (see article: US natural gas rig count down to near 6-1/2 yr low)
Now I'm not a big believer in all of these green shoots that everyone keeps talking about, but even if the economy doesn't recover significantly by the end of the year like many expect, the pace of decline in this recession, and in turn the drop in industrial demand for natural gas will likely slow going forward. According to the Energy Information Administration (IEA), total U.S. natural gas consumption is expected to drop by 1.9% in 2009 and then increase slightly in 2010. That is the sort of stabilization that I am talking about.
Natural gas is a relatively clean power source. Now I'm not one of those fools who believes that the mass adoption of natural gas vehicles, like our friend T. Boone Pickens was pushing for, is likely. However, with the current Administration pushing for CAP and Trade legislation or some sort of reduction of carbon emissions electricity generation from nat gas will likely increase over the next several years. Furthermore, lower relative natural gas prices compared with coal, particularly in the Southeastern United States, will likely encourage the use of it for electricity generation capacity in the near-term.
It could take a while for natural gas prices to recover. It is very possible that we will not see a significant increase in its price until the cool fall weather arrives...unless some sort of major storm hits the natural gas producing section of the Gulf of Mexico this summer, which is always a possibility. The main catalyst for an increase in the price of gas towards the end of the year is the significant is count reduction that I mentioned earlier. The EIA estimates that nat gas will average $4.06 in 2009 and $5.21 in 2010. I am even more bullish on the price of nat gas than that.
I plan on adding the natural gas ETF UNG to my CAPS portfolio today.