The Secret To Trading Natural Gas

| June 10, 2009 | 0 Comments

When I was an investment banker, we were constantly meeting with company management.  The pre-meeting ritual was always the same.  We’d look at recent news, brush up on management bios, and review recent performance.  Of course, we’d also look at the market action of the company stock.

Sometimes the company’s performance was great… strong revenue, growing earnings, and a climbing stock price.

Other times it was ugly.  We’d jokingly yell at the stock chart, “Pull-up, Pull-up!”  Like a pilot flying a plane into the ground, poor company fundamentals always led to a falling stock price.

What trader wants to get in front of a falling stock?

Nobody does.  As they say on the trading floor, “Don’t try to catch a falling knife.  You’ll only end up bloodied.”

Natural gas is a perfect example.

The recession is absolutely crushing demand.

Some of the biggest consumers of natural gas are utilities.  They burn natural gas to generate electricity for their customers.  Here’s the problem.  As demand for electricity falls (due to the recession), utilities buy less natural gas.

I’m sure you’re thinking the same thing I am… “Who would be crazy enough to buy natural gas right now?”

It turns out some of the savviest investors in the world.

Just look at a recent investment by Kohlberg, Kravis & Roberts (KKR).  If you don’t know, KKR is one of the largest private equity firms in the world.  They practically invented the leveraged buyout… and they’ve made billions of dollars for their investors.

Just a few days ago, KKR announced it is investing $350 million into East Resources, a privately held company focusing on natural gas exploration.

The company owns the exploration rights to more than 1.2 million acres. It’s all potential natural gas bearing land.

Why would KKR make that kind of commitment?

Why would they invest $350 million?

What do they know that we don’t?

I had to dig for the information, but it’s all there in black and white.  KKR discovered something interesting.  Demand for natural gas can change very quickly.  Right now demand is down, and so are the prices.

Supply is a little more difficult to predict.  You can’t just flip a switch and expect more natural gas to show up.  You need to drill for it… and drilling takes time.

What’s more interesting is the fall off in new wells.  How’s this for a bit of secret information… Just a few months ago, there were more than 1,600 drilling rigs in operation.

Today, the number is less than 700.

Think about what happens when demand returns.  Consumers will be demanding natural gas, but most of the drilling rigs will be sitting on the sidelines.  It will take a good bit of time to move the rigs back into the field and get them operational… not to mention the time it actually takes to drill these wells.

I think the fall off in drilling will lead to a spike in natural gas prices when demand returns.

And higher prices mean bigger profits for KKRs latest investment.  Take a page from the KKR playbook and add a quality natural gas producer to your portfolio.

One that I like is Chesapeake Energy (CHK).  The company owns outright, or has an interest in, more than 41 thousand oil and natural gas wells.  They have more than 12 trillion cubic feet of proven reserves.  It makes them one of the larger players in the industry.

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Category: Commodities

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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