The Nat-Gas 'Glut' is a Tradable Myth

 | Jul 29, 2013 | 11:49 AM EDT
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I just love it when every generalist in the markets "gets" what's going on in energy. When the universal pundit on stocks fully "understands" what's going on in natural gas, for example, it's time to be wary, assume that a value is emerging, and look again.

The world is convinced that fracking from shale has glutted the U.S. market irretrievably, destroying all the value in the natural gas space forevermore. Those who refuse to acknowledge the completely depressed natural gas market are missing the technological revolution, the overhang of lease mania, the over-leverage that plagues the nat-gas players -- it's all so obvious.

It's so obviously wrong. I trade energy contracts for the short term and trade energy shares for the mid-term, but I find energy trends to generate ideas for the long term. Anyone who has as many years trading energy as I have will tell you that the cyclical nature of energy is the strongest advantage the retail investor has. You've got that advantage right now in natural gas.

The beauty of the generalists being "sure" about natural gas price action is that they are almost always six to 12 months behind the reality -- have a look at this chart of nat-gas storage from the Energy Information Administration. All you need to notice are the total numbers on the bottom line to see how much of a tightening we've gotten in the past year and how we've now finally gone under the five-year average in stockpiles as we head into the dog days of summer.

Nat-Gas in Storage
Energy Information Administration

Add that to the continuing sequester of wells, the continued fleeing of exploration-and-production companies from dry gas toward crude and nat-gas liquids (for obvious reasons), the ramp-up of liquefied natural gas projects and permitting and the arbitrage from the continuing monster strength of gas prices in Europe and Japan, and you've recognized a long-term trend on domestic nat gas that you can buy at virtually pennies on the dollar.

You can see that value already in some Marcellus plays (an area virtually untouched by shut-ins) that are virtually killing it -- particularly Range Resources (RRC) and EQT (EQT). One look at their latest quarterly reports and you'd ask, "Nat gas glut? Doesn't seem to matter to the Marcellus players." And you'd be right.

These were short-term ideas I gave several weeks ago, and the latest report was a certain sell-the-news opportunity to cash out a bit. These trades are so hot that if you're trading them, you must use really tight stops on the positions.

But here are two that require no stops: Ultra Petroleum (UPL) and Encana (ECA). Neither is focused in the super-hot Marcellus, and they have also traded weakly. That's a plus, because both are highly leveraged to nat-gas prices, which we want, and they both are beautifully run. I have a different strategy with these, running somewhat against the grain of trading dogma. Typically, with Encana, the dividend payer, you'd generally like to own the stock. With Ultra, you'd more likely sell puts and hope they get assigned to you, collecting the premium every time you don't get called.

With Encana and Ultra, I've done the opposite, owning Ultra and selling puts on Encana. That's a trader's preference only, and both strategies represent basically the same idea: owning great natural gas companies for the long haul, waiting for the cycle on nat gas to catch up to the slowly restructuring fundamentals.

It's happening, and it won't catch you off guard if you position yourself now. But for the generalists who "know" energy, it almost certainly will.  



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