Natural Gas Slump: How Much Longer Can It Last?

| April 20, 2012 | 0 Comments

Natural gas explorer Chesapeake Energy (CHK) shocked investors earlier this week.  Reuters revealed the company’s CEO, Aubrey McClendon, borrowed $1.1 billion against CHK owned wells in recent years.

McClendon’s actions wouldn’t be a big deal if it weren’t for the fact he took these personal loans without telling CHK investors.  The company denies allegations of wrongdoing, but investors aren’t so sure Mr. McClendon is on the up and up.

How do I know?

CHK dropped like a stone on the news…

Wednesday’s 5.5% drubbing is a black eye for investors who’ve already endured a 25% drop since mid-March.  The sell-off puts CHK at a new multi-year low of $18.00… a price not seen since 2009.

However, much of CHK’s downward spiral has nothing to do with CEO trickery…

The recent bloodbath has more to do with natural gas prices.  The overly abundant commodity is sinking below $2.00 for the first time in 10 years. Since 75% of CHK’s production is tied to natural gas, decade low prices are having a less than desirable effect on their revenue stream.

Why’s natural gas so cheap right now?

An unusually warm US winter kept natural gas demand under wraps over the past few months.  As a result, storage levels are near record levels as summer approaches.

Natural gas in storage is plotted on the red line above.  Look closely and you’ll see current storage is well above the 5-year average storage range (grey shaded area).

Basically, this chart is proof the US is sitting on more natural gas than we know what to do with.  This record supply glut is the sole reason gas prices are in the gutter.

The question now is…

How much longer can natural gas languish at such low levels?

As bad as things are for natural gas producers like CHK, recent developments point to a light at the end of the tunnel.

First of all, the Federal Energy Regulatory Committee (FERC) just approved the first US liquefied natural gas export facility in nearly 50 years.  Energy starved overseas nations are drooling at the thought of getting their hands on cheap US natural gas.

Once the Louisiana based export facility comes online in 2015, natural gas demand will increase dramatically.

But 2015 is a long ways off…

Will it take that long for natural gas prices to get back to a state of normalcy?

Not a chance.

You see, producers are slowing natural gas drilling activity.  As a matter of fact, US onshore natural gas rig counts have been falling for months now.  What’s more, some producers are actually shutting-in production. In other words, they’re capping natural gas wells until prices return to a more profitable level.

But here’s where it get’s interesting…

An overwhelming number of natural gas explorers are focusing future drilling efforts on high-priced oil and natural gas liquids (NGLs).  And once these producers make the switch to higher margin products, they won’t look back.

And that’s the key to the bullish case for natural gas.

Companies who’ve moved to oil and NGL production won’t switch back to natural gas until drilling for it is just as profitable.

What’s this mean?

The current oversupply situation could resolve itself quicker than many analysts are expecting.  And once the effects of ongoing production slowdowns and shut-ins take hold, natural gas prices will surge.

When might we see this rally?

Natural gas producers, including CHK, see prices firming up this fall.  In fact, many of the companies I follow see gas trading at $4 by early 2013… 100% higher than current prices.

How can you capitalize on the looming rally?

Since markets discount information months ahead of time, now’s the time to find ways to profit from an eventual natural gas rally.  One way is to find undervalued natural gas producers and watch them like a hawk.

But a much easier way is to simply watch the First Trust ISE-Revere Natural Gas Index Fund (FCG).  FCG is an ETF holding a number of high-quality natural gas producers.

Once natural gas prices start rebounding, FCG will likely follow suit!

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Category: Commodities

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.

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