Natural Gas Is Headed Lower

Earlier this month, I said that I wouldn't be surprised to see natural gas prices plunge below the $3 mark. I certainly didn't think it would take less than two weeks, but here we are.

With a substantial build in inventories reported by the government on Thursday, natural gas futures dropped more than 5% to the sub-$3 mark for the first time since 2002. So what happens now?

My view is that prices will go even lower from here. I just see nothing standing in the way of a massive storage build over the next few months.

Simple supply and demand
While average daily production peaked several months ago and should soon begin registering more significant declines, the volumes produced should still be enough to either fill the nation's storage capacity completely or at least come close. Many firms have certainly scaled back drilling activity, particularly the private "checkbook drillers." Domestic production already flatlined among the majors like BP (NYSE: BP  ) , Chevron (NYSE: CVX  ) , and ConocoPhillips (NYSE: COP  ) .

That leaves the prodigious independents. The success of E&Ps like Chesapeake Energy (NYSE: CHK  ) , Anadarko Petroleum (NYSE: APC  ) , and XTO Energy (NYSE: XTO  ) -- and the reluctance by those firms to throttle down production growth to a significant degree -- will be the driver that takes gas storage levels to the brim.

The interesting thing is that the stocks of natural gas producers are not slumping along with the commodity price. Rather, they're trading higher as oil hits new highs for the year -- despite the fact that shops like Cabot Oil & Gas (NYSE: COG  ) are well over 90% gas-weighted.

What's next?
Is this disconnect a result of institutional ETF trades moving the entire sector? Maybe. But let's assume this is a display of the market's infinite wisdom, and ability to look past the storage build and to higher gas prices in 2010. If that's the case, why buy into the E&Ps at today's prices?

We can all talk about looking around the corner, but when the gas-on-gas competition starts this fall, will investors really keep their cool? I would personally prefer to see more pessimism before taking a position here.

Fool contributor Toby Shute doesn't have a position in any company mentioned. Check out his CAPS profile or follow his articles using Twitter or RSS. Chesapeake Energy is a Motley Fool Inside Value recommendation. The Fool owns shares of Chesapeake and XTO. The Motley Fool has a disclosure policy.


Read/Post Comments (7) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 22, 2009, at 2:43 AM, footchester wrote:

    <I>Long term I'm bullish on both oil and natural gas prices but it seems to me that right now the better value buy is natural gas at record lows than oil at 74$ a barrel is.</I>

    But short of entering into the natural gas storage biz, how do investors take advantage of the low gas price? Any company that is involved in natural gas is probably even more involved in the oil biz. I can't purchase a few million cubic feet of naturarl gas and store it in my basement, so how do I take advantage of a commodity price that is sure to rise?

  • Report this Comment On August 22, 2009, at 3:03 AM, automaticaev wrote:

    ya ill buy some if it goes lower. be a nice add to my port

  • Report this Comment On August 22, 2009, at 7:27 PM, Xabbo wrote:

    Footchester,

    You could buy an ETF such as UNG.

  • Report this Comment On August 22, 2009, at 8:03 PM, olsonda1 wrote:

    Two things, producers are full out because their hedges in place extend through this year and maybe next. Chesapeake has its gas sold for 2009 around $7 and for 2010 around $8. Read their press releases recently. Why cut back???

    Secondly, Users of Nat gas who can switch fuels are using the hell out of coal in anticipation of Cap and Tax. This will be the base period for carbon emissions and coal emits between two and three times as much carbon dioxide. After Cap and Tax, they only need to switch to nat gas to achieve all their emissions quotas for next ten years! I'd be foregoing nat gas in favor of coal right now too.

  • Report this Comment On August 22, 2009, at 8:13 PM, NOTvuffett wrote:

    I don't know if nat gas is going to go back to historical price relationship with oil. It is a more regional commodity and there have been significant finds and development of nat gas production in the last couple of years.

    Xabbo's suggestion to buy UNG while nat gas price is so low seems reasonable to me.

    I am long on oil and nat gas with real money, no matter how much people may want to change our dependence upon them, that time is not close.

  • Report this Comment On August 23, 2009, at 12:44 AM, Kisei wrote:

    UNG is currently trading at a premium to NAV because it is not accepting new money (ie it is now trading like a closed end fund). This is due to worries that regulators may impose a limit on the amount of futures ETFs can buy, thus impinging on their ability to grow beyond a certain size.

    Another way to play nat gas is through a pure play E&P such as Contango (MCF). MCF is trading at a level close to the value of their proven reserves.

  • Report this Comment On August 24, 2009, at 9:33 AM, rankincap wrote:

    The independents of the shale play are drilling full out because they have leases they have to drill. In their rush to secure all the Shale leases they created a gold rush mentality and paid upwards of $30,000 an acre with 27% royalties and then giving landmen overriding interest. If they do not drill the leases they have lost all their lease money, so they will drill reguardless of the price of gas.

    I will buy the gas companies again when they retreat a bit.

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