Time to Talk Natural Gas

 | Jan 30, 2014 | 4:00 PM EST  | Comments
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We have to talk about natural gas. It's recently been the most volatile commodity by far and, truth be told, a fantastic long-term investment for the past year. So, is there still opportunity in the space? And what should we make of this mercurial commodity now?

Looking at a long-term chart of natural gas, you'd have made quite a score over the last year just by being long. Since a spot price low below $2 per thousand cubic feet (Mcf) in the spring 2012, we saw futures top $5.50/Mcf briefly Wednesday before February futures expired. Even my most-hated exchange-traded fund, the United States Natural Gas Fund (UNG), rallied to above $26 from $18 since early December.

Much of this recent rally has obviously been due to extreme cold reaching far into the Deep South. The market itself is expressing the short-term nature of this phenomenon as well: While March is trading today at $5.10/Mcf, futures for May are trading at $4.35/Mcf and are below $4/Mcf as soon as the spring of 2015. This deep level of backwardation in the curve of prices is a classic indication of short-term conditions affecting front-month futures while not greatly affecting longer-term price expectations.

But here's the thing -- and a most important thing it is: Future price curves of most commodities are notoriously bad predictors of future price action. Just look at the recent activity of natural gas itself if you want proof. After an initial run above $4/Mcf at the start of January, developing an already deep $0.30 premium, temperatures in the Northeast moderated and gave natural gas the strong opportunity to back off again toward and below $4/Mcf -- but it didn't. I viewed this action as exceedingly bullish (but did not recommend or act on it) and, sure enough, it presaged another massive run to a high in the February futures of $5.72 before expiring Wednesday. Indeed, that discount to the March futures sunk many of the traders depending on the short-term nature of the move as March futures drove higher, also settling at $5.52 yesterday.

I will not be fooled again. Temperatures are scheduled to again moderate starting this weekend and we'll see no more ice in Atlanta soon, and natural gas is already off more than $0.35/Mcf today. All things being equal, and if the futures curve is correct in its futures pricing, that deep backwardation should moderate and/or spot prices should come down well below $5/Mcf.

But if that doesn't happen, I'll be a hair-trigger ready to buy nat gas futures out on the curve where the prices still hover around $4.35/Mcf and below. There are fundamentals to believe that $5/Mcf gas prices will be sustainable. LNG exports are going to start rolling with the completion of the Dominion (D) plant in 2014, there is continuing sequestration and dropping stockpiles, and President Obama's latest talk of natural gas in the State of the Union address.

And what of the natural gas stocks? Most have shown limited upside to this weather-induced move: Ultra Petroleum (UPL) moved to $24 from $21, Chesapeake (CHK) is in a rut at $27; Devon (DVN) has traded horribly. If $5/Mcf nat gas comes back for real and for good, that's about to change for these stocks and others.

Here's a natural gas stock that I think has value and upside if you want to play a long-term natural gas opportunity and are wary of the futures themselves: Southwestern Energy (SWN). See my previous columns for my rationale on that one, but at $42, I like it for the long haul.

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