How About This Natural Gas Relative Value Play?
In his speech to Congress today, Alan Greenspan suggested that natural gas
(NG) inventories in the US
aren’t growing fast enough to offset demand and could pose a problem for certain
elements of the economy going forward. As a result, natural gas futures
and companies directly related to the commodity shot higher during today’s
trading session. But this is not a new development. Industry insiders have been
warning about this shortfall for the several months now, and NG companies, such
as XTO, have been steadily climbing as a result.
The reason for the current situation in NG is that (unlike with oil) the US
depends on domestic producers to meet its demand for the commodity. But NG
inventories are running at very low levels due to both supply and demand
factors. For instance, most of the active NG fields in North America where
shallow when they were inaugurated and are now running at low levels; moreover,
new deposits have not been tapped quickly enough to offset the looming shortfall. At the same time, demand for natural gas increased dramatically this past year
due to a colder than normal winter — thus further exacerbating supply. And
unless NG inventories are replenished ahead of next winter, the price of NG
futures and stocks in companies that produce the commodity could increase
dramatically.
Now that the beneficiaries of the NG drama have been established, let’s look
at a potential loser…
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
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dependant on natural gas than some of their peers. Conversely, Praxair
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and DuPont
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be the least negatively exposed companies in the chemical sector.
A sustained shortfall
in natural gas could therefore offer some attractive relative value plays in the
chemical sector in the months ahead.