Tuesday, April 28, 2009 0 comments ++[ CLICK TO COMMENT ]++

If you are a contrarian and believe in re-flation, worth considering natural gas

I'm mildly bearish on commodities and don't really believe in the re-flation scenario, which is pinned on strong economic growth. But if you disagree with those views, and I suspect many readers are :), you may want to do some homework on natural gas. Strictly from a contrarian point of view, it is starting to look attractive. As you can see in the chart below from barchart.com, its price has declined quite a bit and is possibly on its way to a decade low.

Without looking at fundamentals and strictly looking at that chart, it is probable that natural gas can fall another 40% to, say, $2. This was the price back in 1999 and 2001-2002. If you assume that fundamentals, either on the production or demand side, hadn't changed much and value of the US$ hasn't changed much, it wouldn't be unreasonable to expect prices to go back to the lows set a decade ago.

Has the Fundamentals Changed?

I don't follow the natgas market but did read up on it several years ago (when I was actually bullish on commodities and shortly owned a coal-bed methane play.) The fundamentals for natgas is probably slightly bearish right now. Here is my thinking, without doing much research.

Historically, and still to a large degree, natgas has been a localized market. What drives prices in America is almost entirely the North American economy (this is not the case with oil.) I am quite bearish on the economy even though we may have seen the worst already. Although the total North American GDP is higher now than a decade ago, one can't blindly assume this means higher prices since efficiency may have improved as well. Demand may also have changed. For instance, natural gas was somewhat popular as an energy source for power plants in the late 90's but nowadays very few seem to favour natgas for electric power plants. You can see the localized nature of natgas by noticing how you have wild price swings (unlike oil.) A lot of that is driven by localized weather—such as hurricanes.

Natgas also seems to have a major bearish event that didn't exist a few years ago. Although a still small component, America is starting to import quite a bit of LNG (liquified natgas). The following Bloomberg article provides some details:

“Oversupply is all but certain to persist in the near term, with liquefied natural gas imports starting to ramp up in addition to still-robust domestic production growth year over year,” Biliana Pehlivanova, an energy analyst at Barclays Capital in New York, said in a note today.

Imports of LNG may rise to 480 billion cubic feet this year, up 36 percent from last year’s 352 billion, as global demand for the fuel declines and output from the Middle East and Asia enters the market, the Energy Department said on April 14. The estimate was 26 percent higher than a March forecast.

LNG is gas that is cooled to a liquid for transport by ship to markets not connected by pipelines. The fuel is received at import terminals and converted back to a gaseous form so it can be piped to users.

April imports of LNG are averaging 1.3 billion cubic feet a day, or 44 percent more than the same month a year earlier, David Pursell, a managing director at Tudor Pickering Holt & Co. LLC in Houston, said in a report today.

Imports were 25 percent higher in the first quarter of the year compared with the same period in 2008, he said.

This LNG source is not going to decline easily. I have to do research to confirm this but I belive the cost of production in foreign regions (like the Middle East or Russia) is far lower than in North America, for the most part. If you are investing in natgas for macro reasons, you better make sure that the LNG imports don't cause oversupply for years. Natgas does not have a cartel like OPEC putting a floor under the price. It will come down to marginal cost of production.

Still Worth Considering

The environment right now is different from when I was investing back in 2005. Back then, demand was growing strongly and prices were going up. Hence many of the natgas producers were expensive. Right now, in contrast, the market is distressed. Many natgas producers are cheap and some are on the verge of bankruptcy.

It is probably safer to invest in natgas companies now than at any point since 2001. I think if someone can do their homework and pick a few companies at low valuations, it may work out. If you believe in strong economic growth then this industry seems attractive and is probably safer than it seems. I personally am concerned about economic growth and hence perceive natgas as risky so I'm staying away. But I am keeping my eyes open, in case I'm wrong, and may change my mind. A natgas producer may be a good investment coming out of a severe recession.

I have to do research since things have changed over the years but, if interested, one should consider the full spectrum from the largest to the smallest producer. If I'm not mistaken, the lagest natgas producer is ConocoPhillips but that's not a pure play. The largest independent pure play is Encana if I'm not mistaken. Others such as Apache are also worth considering. Chesapeake is another major player that is distressed. When I was investing there were countless juniors but many may have gone bankrupt or dissapeared (mergers & acquisitions) now. Contrary to what many believe, if you are superbullish on a commodity, you should consider high-cost producers. These are typically companies involved in unconventional sources such as coal-bed methane or shale gas.


No Response to "If you are a contrarian and believe in re-flation, worth considering natural gas"

Post a Comment