What’s Up With Natural Gas Heading Down?

by Aaron Levitt | November 30, 2012 6:30 am

After spending much of the year bouncing off historic lows — futures even slipped below $2 per million British thermal units — it seemed that prices for natural gas had turned a corner.

The response by various producers like Chesapeake (NYSE:CHK[1]) was to curtail production and switch to more profitable natural gas liquids (NGL) and shale oil in the face of huge inventory buildups.

And that had finally begun to bear fruit. Prices for the abundant fuel had steadily climbed upwards and it seemed like natural gas[2] may finally have its day in the sun once again.

Unfortunately, now that “sun” is the big problem.

Hurricane Sandy aside, the weather just isn’t cooperating for stronger natural gas prices. With more warm weather on the way for December, investors in the fuel could be in for another month of pain — but one that could be a great buying opportunity.

Biggest Drop in Five Weeks

Last week, natural gas surged to a 13-month high as government data pointed to a bigger-than-expected supply drop. That supply drop, however, looks poised to be short-lived as various weather forecasters like MDA and Commodity Weather Group now predict above-normal temperatures for the lower 48 states over the next few weeks.

Temps for the Northeast in the start of December will average roughly 8 to 10 degrees above normal, while around two-thirds of the U.S. is expected to see unseasonably balmy weather[3]. And while temperatures further out into late December and early January will drop according to models, there won’t be any extreme frigid weather to make up the difference.

Those higher-than-normal temperatures will put pressure on the fuel as heating demand wanes. About half of U.S. households use natural gas for heat and analysts predict that overall heating demand for the first few weeks of December[4] that’s about 34% lower than normal. That lack of demand puts additional pressures on the already large stockpiles of the fuel.

Those pressures already seem to be having their way with inventories. According to the Energy Information Administration, the latest storage numbers for natural gas rose by 4 billion cubic feet last week to sit at 3.877 trillion cubic feet, while analysts had been predicting a drop of around 7 billion cubic feet. Overall, the surplus of fuel[5] continues to grow year-over-year.

Given the hot weather, lack of demand and rising storage numbers, it’s easy to see why natural gas has basically imploded[6] over the week or so. The fuel had rallied on the back of warmer summer weather and increased air conditioner use.

But as they say “The Lord (or Mother Nature) giveth, the Lord taketh away.”

Prices for fuel have fallen from a recent high of $3.93 all the way down to $3.65 over the last week — and the pain for the fuel could just be starting. Based on an average 20-year decline of 40% that begins around late November, analysts are now predicting that we could see natural gas prices back at $2.30 or lower by February.

Opportunity in Bad News

With warmer weather coming to a Christmas near you, the natural gas producers — and their share prices — should drift down lower over the next month or so. That weakness could be a prime time for investors to take an initial bite out of the sector or increase their exposure[7], though.

See, the key piece to natural gas’ future has always been finding new sources of demand[8]. That demand is starting to grow as more utilities switch over to the fuel, chemical firms use it to produce ethylene, it gets exported and so on. Investors need to think of the sector as a long-term energy play and any dips — like the one we are about go into — should be used as a buying opportunity.

Here at InvestorPlace, we’ve highlighted[9] plenty of ways for investors to gain access to the fuel. My favorite still remains the broad First Trust ISE-Revere Natural Gas Index (NYSE:FCG[10]). The ETF covers a virtual who’s-who of players — such as EnCana (NYSE:ECA[11]) and Ultra Petroleum (NYSE:UPL[12]) — and has been subject to some pretty big price swings as the fuel has moved up and down. Overall, it still remains the best broad-producer play on the sector and is one of the cheapest options as well.

For those investors looking for a trade on the dip in prices and subsequent summertime rally — assuming we get one — both the ProShares Ultra DJ-UBS Natural Gas (NASDAQ:BOIL[13]) fund and VelocityShares 3x Long Natural Gas ETN (NASDAQ:UGAZ[14]) could be for you. The funds respectively offer 2x and 3x the price change in natural gas futures. Are they leveraged? Yes. Can they incur big losses? You bet. But they also offer some of the “biggest bang for your buck” when the fuel rebounds … I just wouldn’t buy them until temperatures start cool off.

All in all, the important thing to remember is that natural gas is continuing to be quite a volatile play — and investors should use the dips to position themselves for the long term.

As of this writing, Aaron Levitt did not own a position in any of the aforementioned securities.

Endnotes:
  1. CHK: http://studio-5.financialcontent.com/investplace/quote?Symbol=CHK
  2. natural gas: http://investorplace.com/hot-topics/natural-gas/
  3. unseasonably balmy weather: http://blogs.barrons.com/focusonfunds/2012/11/26/balmy-weather-forecast-crimps-natural-gas-bets/?mod=yahoobarrons
  4. December: http://investorplace.com/2012/11/options-for-making-the-holiday-season-merry/
  5. surplus of fuel: http://investorplace.com/2012/10/how-to-play-the-progress-in-natural-gas/
  6. basically imploded: http://investorplace.com/2012/10/new-pipelines-could-chill-natural-gas-prices/
  7. increase their exposure: http://investorplace.com/2012/09/get-ready-for-a-fourth-quarter-sale-on-energy-stocks/
  8. new sources of demand: http://investorplace.com/2012/11/jack-welch-may-be-crazy-but-not-when-it-comes-to-natural-gas/
  9. highlighted: http://investorplace.com/2012/10/5-t-boone-pickens-plays-eca-kwk-ung-chk-fcg/
  10. FCG: http://studio-5.financialcontent.com/investplace/quote?Symbol=FCG
  11. ECA: http://studio-5.financialcontent.com/investplace/quote?Symbol=ECA
  12. UPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=UPL
  13. BOIL: http://studio-5.financialcontent.com/investplace/quote?Symbol=BOIL
  14. UGAZ: http://studio-5.financialcontent.com/investplace/quote?Symbol=UGAZ

Source URL: http://investorplace.com/2012/11/whats-up-with-natural-gas-heading-down/
Short URL: http://invstplc.com/1fub3c2