You Need to Be in the Nat-Gas Trade

 | Jul 30, 2012 | 2:00 PM EDT
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One chart -- that's all I need. One chart to convince me, and hopefully you, that natural gas is the trade you must be in for the rest of the summer and into the third quarter. Only one chart from the Energy Information Administration -- and here it is:


Weekly Nat-Gas Storge
Energy Information Administration


This chart shows the amount of nat gas in storage, now hovering around 3.1Tcf, against the five-year weighted average of storage, represented by the shaded area. The first read gives you what you already know: Since the first of the year, natural gas has been a glutted market. The industry has overproduced, because of a surge in hydraulic fracturing and because leases in gas fields have forced many wells to be drilled, despite their economics.

We had a very mild winter, and usage for nat gas was lighter than in virtually every recent season. Utilities' conversions to natural gas and conversions of trucks and other vehicles to natural gas have been slow, finding little political support despite the many advantages. Consequently, since the first of the year, we've seen storage greatly exceed the five-year average, and the fuel trades as low as under $2/mcf.

We know all that.

But look at the trajectories of the two lines now, entering the late summer and into the fourth quarter. Look carefully. That's right -- the current storage is quickly converging to the five-year average and looks like it will drop beneath that shaded area if the trends continue, by the end of the fourth quarter.

That because the big natural gas companies have had some limited success with sequestering of wells, led by Chesapeake Energy (CHK), which has begun to drop production. Some power conversions from coal to natural gas are about to be completed. But the biggest support for natural gas has come from the weather, a historic heat wave across the middle of the country that began in late June and has continued with little relief through July and, if forecasts are correct, into August. That has put unprecedented pressure on power grids to produce power for air conditioning, which is by far the single biggest user of natural gas.

The heat wave is quickly eating up the surplus of natural gas.

It's already having its effect on the price of natural gas, which now trades over $3.10/mcf and is, I believe, on its way to over $4 by sometime early in the fourth quarter. That's a doubling of price that is not yet reflected in any way in the dedicated natural-gas stocks. This makes nat-gas stocks not only the best value sector in energy but some of the best medium-term stocks to own in the entire S&P 500, in my view.

The names I will give you to buy and hold for the next several months will come as no surprise to regular readers, as my favorites in the space haven't changed at all. They include Encana (ECA), Ultra Petroleum (UPL), Devon Energy (DVN), Exco Resources (XCO) and SandRidge Energy (SD). Don't be fooled particularly by Encana -- every piece of news of the Michigan price-fixing scandal that drops its stock is an opportunity to buy, just like the rest of these names.

There's still value in the energy space -- in natural gas.

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