Why Traders Will Be Watching Natural Gas
Back in early March, I first touched on the supply shortfall in natural
gas and how it could potentially affect certain industries, specifically the
chemical industry. Since that time,
however, the fundamental factors governing the price of this commodity remain
precarious and prices have continued to climb, becoming a major source of
concern for many market observers and participants–including Alan Greenspan,
who mentioned this shortfall in his economic update to Congress a couple of
weeks ago and who will devote an entire Congressional testimony to discuss the
implications of the matter tomorrow.
As such, due to the growing chorus
of concern about natural gas, I will highlight some important points about this
situation in today’s column. Readers should also know that most of the tight supply is already priced into the markets and a worst case scenario is not expected as of yet.
What’s the Big Deal?
The US economy, including consumers and
corporations, has become increasingly dependant on natural gas. Specifically,
half of American households rely on natural gas to heat their homes. Forty
percent of all natural gas is consumed by the industrial sector; 24% is used
for electricity generation; 14% is used for commercial purposes and 2% is used
for transportation. Additionally, NG consumption is expected to grow to 28.5
trillion cubic feet (tcf) by 2010, from the current 20.2 tcf. So, it’s pretty
obvious that high sustained NG prices could have a negative impact on the
economy next winter (when demand is highest) unless inventories are replenished
in time.
What’s Causing the Shortfall?
Natural gas is much more difficult to transport than other sources of fossil
fuel/energy, and as a result, the US depends on domestic producers to meet
demand for the commodity. Unfortunately, however, a confluence of factors have
caused current reserves to reach dangerously low levels. These include:
- NIMBY “not in my back yard” and BANANA “build absolutely nothing anywhere
near anyone” opponents of domestic natural gas exploration have given
developers little choice but to tap into shallow NG fields in the Gulf of
Mexico, as opposed to the larger more abundant fields in other areas of North
America. - Demand for natural gas increased dramatically this past year due to a
colder than normal winter, which depleted reserves to their lowest level since
1976 (see chart below).
Current Supply
Spencer Abraham, the US Energy Secretary, said that the US had 696 bcf of gas
in storage at the end of March, the lowest since 1976 when record keeping began.
Since hitting the trough in March, NG reserves have almost doubled to 1.2 tcf.
However, supplies still remain below the 1.95 tcf of gas storage at this time
last year.
What to Look For Going Forward
Every Thursday, the Energy department reports the level of reserves to the
market. At the very least, reserves will have to grow to 2.8 tcf in the next
five months, before the winter months when demand is highest. So investors
should monitor the weekly reserves number in order to get a sense of whether or
not this goal can be accomplished.
Possible Areas of Opportunity
Much of the current supply shortfall is already priced into the markets.
However, if temperatures this summer prove to be particularly high, then extra
electricity generation will divert NG supplies away from the build-up of
reserves for winter. Therefore investors can make several NG plays including
buying NG producers, such as Apache
(
APA |
Quote |
Chart |
News |
PowerRating) and XTO
(
XTO |
Quote |
Chart |
News |
PowerRating), or they could
also consider relative value plays in chemicals industry.
Chemicals
Natural gas is an integral component in the synthesis of certain goods, such
as ethylene, that are produced by chemical companies. Higher NG prices would eat
into profits at companies that depend on this commodity since production costs
would be higher during a supply shortfall. However, not all chemical companies
depend on natural gas for their production process and instead use oil, which is
not as scarce. Dow Chemical
(
DOW |
Quote |
Chart |
News |
PowerRating), Lyondell
(
LYO |
Quote |
Chart |
News |
PowerRating) and NOVA
(
NCX |
Quote |
Chart |
News |
PowerRating) are
significantly more dependant on natural gas than some of their peers.
Conversely, Praxair
(
PX |
Quote |
Chart |
News |
PowerRating) and DuPont
(
DD |
Quote |
Chart |
News |
PowerRating) are more dependent on oil for
their goods and would probably be the least negatively exposed companies in the
chemical sector.
Â