As mentioned in my Natural Gas Outlook, I am forecasting natural gas prices to rise and possibly double in the next 12 months.  If you haven’t read that post, please do.  It contains a number of slides from a recent presentation I gave on the topic.

The problem with betting on commodities is the extremely high carry cost for holding futures that far out.  So you can either swing trade natural gas with a long bias, or use equities as your trading/investment vehicle.

So Here’s The Trade:

Let’s start with the US Nat Gas ETF, $UNG.  Full warning here – this is a terrible long term ETF to buy and hold – it’s design will cause it to underperform natural gas spot prices over time.  Therefore, only use it as a swing trading vehicle; I’m talking time-frames of days to, at most, a couple weeks.

I’d like to see $UNG consolidate above $7.00 for a few days before taking a stab at the long side.  It’s very volatile so use stops and trade it very tight:

 

A better approach for a longer time-frame investment would be equities.  In this respect I have 3 companies that I think could be useful for upside natural gas exposure:

Long: $EQT (EQT Corporation) – at 25% of position

Long: $CNX (Consol Energy Inc) – at 25% of position

Short: $LNG (Cheniere Energy Inc) – at 50% of position

As you can see with the relative position sizes above, I think a three-way trade with 50% long and 50% short equity exposure will keep you relatively net neutral the overall market.

In addition, I think you should only pull the trigger on each leg of this trade when each individual stock actually breaks out.  So far, I am only in the $LNG portion, as I’m waiting for $CNX and $EQT to consolidate and show some further strength.

Refer to the charts and levels below:

 

I may give a follow-up on the fundamental reasons behind these 3 picks, if interested?

Be sure to follow me on Twitter @dyer440.

 

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I recently gave a presentation on the Natural Gas market at work and I think it could be beneficial to iBankCoin readers.  The following is a summary of the talk and I’ve used some of the graphs/charts from my slides in this article.

Natural Gas prices are currently at historical lows mostly due to the shale fracking boom.  The low prices are driving a number of factors that are leading to increased consumption, mainly LNG exports and Coal to Gas power fuel switching derived from new environmental regulations on coal fired power plants.  The net result has been increased production and also increased consumption.  We are in an era of seemingly cheap fossil fuels and the utilization of cheap natural gas has been dramatic:

The supply/demand balance is very well correlated to prices and I’ve used the relationship between the two time series to establish a forecast for prices through 2017, refer to the chart below.  As you can see from the chart, the EIA has projected demand to outpace supply for most of 2017 which should lead to higher prices:

The U.S. is historically a net importer of natural gas from Mexico and Canada however, the situation is changing due to the abundance of production from the shale boom.  The net affect on the natural gas supply/demand balance moving forward will be impacted by increased LNG exports and pipeline exports.  It’s often overlooked that pipeline flows in certain areas have actually reversed.

By the end of 2017, the import/export volumes should be about even; by 2018 the EIA has projected the U.S. to be a net exporter of natural gas, see below:

Another way of looking at future natural gas prices is to use the year over year inventory levels.  As you can see from the EIA’s chart below (which I modified), the natural gas inventory levels are drawn down each winter predominately due to home heating usage; once spring comes around the inventories are built back up.  Inventory levels are currently above their 5 year averages due to the very mild 2015-2016 winter. It appears the EIA used an average winter next year and estimated average draws on natural gas storage.

Similar to the supply/demand balance shown above, we can use the year over year inventory levels to project future natural gas prices (albeit with different inputs).   As you can see below, inventory projections suggest prices well above $4 (MMBTU):

Although the technological advancements in the shale fracking space have led to cost savings, the practice is still very capital intensive.  Steep decline curves result in a hamster wheel effect of spending CAPEX on drilling and stimulating well fields, followed by more spending in order to keep production growing.  Once the CAPEX is cutoff, it’s only a matter of time until production levels decelerate year over year and eventually decline.

I believe we are currently in the deceleration phase and the natural gas production figures will soon begin to decline.  Most of the shale basins have already witnessed peak production.  I don’t think they are in terminal decline per se, only that additional capital will have to be spent in order for production levels to rebound.  Overall, CAPEX in the energy sector has fallen dramatically and it appears the period of easy money is over.

The Shale Boom was built on the back of a Debt Boom.  Easy money from the Fed’s multiple rounds of QE combined with increases in fracking technology led companies to believe a real energy revolution was taking place.  E&P companies levered-up their balance sheets and boom towns were created form south Texas to North Dakota.  This story has played out many times historically… the Debt Boom turns into a Bankruptcy Boom as prices fall dramatically due to oversupplied markets.

Energy companies across the board are seeing debt downgrades and deteriorating credit quality.  The period of easy financing is over.  In order for additional capital to be allocated to new energy investments, prices for these commodities will have to be higher than they are today; ROI’s will demand it.

As you can see, without additional spending the shale boom may be over.  The problem is, most project continued growth through 2040 with prices below $5 (MMBTU) for the entire period!  I think these estimates are absurd, refer below for the EIA’s natural gas production projections without the Clean Power Plan:

In summary, the EIA projects prices will rise above $3 per MMBTU sometime next winter.  My own work suggests natural gas prices will reach the $4.00-4.30 range.

Whether in the E&P space or even in the coal sector, there will be opportunities to profit from a rise in natural gas prices.  I will do a follow-up article on potential investments stemming from this idea, so stay tuned.

Please feel free to share your thoughts in the comments below and follow me on Twitter @dyer440.

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In early December 2015 I warned not to touch commodities until specific currency levels were breached on the USD/YPY and EUR/USD crosses.  For reference: Calling All Degenerate Oil Gamblers!!.

I was specifically referring to crude oil and energy related exposure.  That was back when everyone was calling for a bottom in crude every other day.  I remained short energy exposure and it generally worked out.  Now it’s time to revisit those currency levels because the Yen Carry Trade is unwinding.  This has led many to question what the hell is going on – including myself.

From my article:

Stay away from Long Oil exposure (and commodities in general) until:

1) The USD/JPY cross falls below 115.50, AND

2) The EUR/USD cross trades above  1.148

The USD/JPY level has been breached due to the unwind, the EUR/USD has not (yet):

 

The interesting thing to note regarding oil and energy is the decoupling from US Dollar correlation.  I believe this is a testament to the weakness in crude oil and energy related names.

On the other hand, it may be time to look at non-energy related commodities.  Is this the turn?  Is inflation (or US Dollar devaluation) on our doorstep?  If you’re listening to the story Gold is telling, you may be inclined to think so.  Instead of chasing gold higher, I’ve got a better idea.

Here’s the Trade:

Continue shorting oil & gas related companies and derivatives, I like these two:

• $USO
• $UNG

I would also stay short energy related equities.  I would recommend one or two but I no longer have an edge in any of them specifically now that $COP cut their dividend (as I warned multiple times here).

So here’s what is happening: the  oil & gas companies in the US are pumping whatever they can simply to bring in cash flow.  The cash is not returning a positive return on their initial investment, but at least it’s returning cash – which these companies desperately need to pay their bills (and notes).  Bottom line is they are NOT cutting production, they cant.

They’re in a financially engineered negative feedback loop.

The Saudi’s will not come to the rescue.  I’ve given you their script already, here.

Good luck out there, and follow me on Twitter @dyer440

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