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  1. Home
  2. / Investing
  3. / Energy

Don't Trust the Weather Trade

Maybe try futures, but be wary of natural gas stocks.
By DANIEL DICKER Sep 26, 2014 | 09:30 AM EDT
Stocks quotes in this article: SWN, RRC, COG

For a lifetime trader of fossil fuels, it has been like living in the dark. I have never seen a better market to be long crude oil, where the risks to the upside were, to me, exponentially deeper than the possibilities to the downside. But my shrinking profit-and-loss statements have been a contrary indicator to be sure.

Natural gas has been almost the exact opposite, where downside risks are far more numerous than the possibilities for a big move higher. Yet, considering the moderate summer we have just come through, natural gas is showing some surprising strength. As with crude oil you have to ask -- what is going on?

One chart I love to start the conversation on natural gas with is this one from the Energy Information Association:

U.S. Dry Shale Gas
EIA-Drillinginfo, Inc.
View Chart » View in New Window »

Even for those of you who are aware of the shale revolution in the U.S., this serves as a fantastic representation of just how incredible the growth in gas production has been.

Remember, that while U.S. crude demand will never be satisfied by U.S. production, natural gas production from shale has almost completely satisfied what the U.S. uses. Ultimately, the excess produced has nowhere to go.

There has been hopeful talk from natural gas advocates about a conversion in the U.S. to a "gas based" energy infrastructure. That would mean transport trucks and cars running on U.S. shale gas, utility plant conversions, gas-to-liquids (GTL) projects and a very interesting new technology of GTL (which I'll get to another time).

But for all the opportunity that "Saudi America" seemed to hold in the last several years, little has actually progressed . And it has not been nearly enough to soak up the parabolic growth in production you see in the graph above.

Why is natural gas hovering still near $4 per thousand cubic feet (mcf)? The fundamentals for natural gas look almost as bad as the fundamentals for crude oil look good.

Stockpiles have again been above the five-year average and there were two straight months of sub-90-degree summer temps. Many traders (including me) expected prices to substantially sink below $3.50 mcf coming into the fall.

So what's happening? Here's my take on it, and, as usual, it concentrates away from the fundamentals and almost entirely on the financial inputs into price.

Last year we had one of the most brutal winters on record, with six straight weeks of sub-freezing temps in the Northeast -- an almost unheard of cold snap. This drove natural gas prices briefly above $6 per thousand cubic feet.

You wouldn't believe it (I don't), but several of the long-range weather forecasters are predicting a winter equivalent to 2013. Some are looking at temperatures even more severe.

I imagine that the commodity hedge fund players are happily ignoring the fundamentals of rapidly-increasing supply (and infrastructure overloads), and making a very calculated risk/reward trade on natural gas at below $4 per mcf. If we catch a winter like last year, you will make perhaps $2 on a spike. If we don't get one, you will risk perhaps $0.30 or $0.40.

This might be a great reason to trade some futures, but I cannot recommend a natural gas stock from it. All of the Marcellus plays that I normally follow look like very difficult buys,  including Southwestern (SWN), Range Resources (RRC), Cabot (COG) and EQT (EQT).

I hate the weather trade -- you can't trust it. Because of that, I'm staying clear of natural gas stocks right now.

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At the time of publication, Dicker held no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity | Energy | Stocks

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