Could Natural Gas Prices Catch Fire?

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It's supposed to be the transition fuel of the 21st century. It's the fuel source that ExxonMobil bet $41 billion on when it acquired XTO Energy in 2009. And it's also the commodity that is up 40% in the last four months. 

Natural gas prices have been on fire, with Henry Hub futures contracts recently trading around $5/MMbtu. Can the commodity keep rising with the trend?

Lower supply and unseasonably cold weather
Natural gas prices have come a long way from 2012, when they were trading around $2/MMbtu.

Since that time, in order to reduce supply, many natural gas producers, such as Chesapeake Energy (NYSE: CHK  ) and Range Resources (NYSE: RRC  ) , have cut back on natural gas production and focused more on producing higher-margin liquids. 

The total U.S. natural gas rig count has fallen steeply as well. According to Baker Hughes, the U.S. natural gas rig count was only 351 on February 7, versus 600 in 2012 and over 1,600 in 2008.  

On a five-year timeline, natural gas demand has risen as utilities increasingly choose cleaner natural gas over coal. According to the EIA, natural gas now accounts for roughly 27% of all electricity generated in the U.S. versus only 21% in 2008. 

The greatest reason for the recent rise in natural gas prices is the unseasonably cold weather. Because of frigid temperatures and several major winter storms, natural gas storage levels are 28.8% below year ago levels and 22.4% below the 5-year average. The unexpected draw-down has led some utilities to ask consumers to conserve power while leading to greater volatility in futures markets.  

The bottom line
Natural gas contracts typically trade lower in warmer months. This year is likely to be no different.

According to CME futures, despite the recent bullishness, the market thinks natural gas prices will be range-bound between $4/MMbtu and $5/MMbtu over the next two years. 

The Energy Information Agency also expects natural gas consumption to stay relatively flat this year. The agency expects natural gas consumption for 2014 to average around 70.2 billion cubic feet per day, or a 1% decrease over 2013.  

Many believe that natural gas prices will only rise in the long term if the Obama administration approves more LNG export terminals. Global LNG prices are currently much higher than domestic natural gas prices. According to the Energy Intelligence Group, the spot price for LNG is around $19 in Japan and $15 in Europe. 

On February 11, the U.S. government approved a Sempra Energy (NYSE: SRE  )  LNG export terminal in Louisiana. The approval is the sixth over the past 12 months. 

Because of concerns that high natural gas prices will lower U.S. manufacturing and chemical industry competitiveness, however, some investors believe the Obama administration may be more stingy in its LNG export terminal approvals going forward. 

Being range-bound between $4 and $5 may be the best thing for natural gas in the long term. The price is high enough to encourage production, but not high enough to choke future demand. 

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  • Report this Comment On February 15, 2014, at 9:03 PM, dobieg wrote:

    It's hard to take some of the writers seriously when they don't even do basic research. 1st, the cost of a shale well runs anywhere from $7 - 10 million. That equates to a cost of $4- 7 to make drilling deep shale wells profitable. Then add into the equation the more than expected depletion rate of these wells at 60 - 70% after the 1st 2 years and you can see why the rig count has gone down from around 1400 to 350 today. If anyone believes NG drillers will increase production while they lose money, perhaps you should follow this writer and take his investment opinion.

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Jay Yao

Jay is an energy and materials writer. He reports on oil and gas fundamentals and macro trends in the industry.

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