HardAssetsInvestor

Written by Amine Bouchentouf  |

June 26, 2012

The Commodity Investor: NatGas Prices Heading Higher In Medium & Short Term, Making UNG Attractive

Details

While natgas producers seemingly have a grip on supply that should support prices, investors need an active and aggressive strategy in this volatile market.

Natural gas has traditionally been one of the most volatile commodities out there. It’s common to see this commodity up triple digits one year and down double digits the next.

You could even say that trading natural gas is akin to gambling, hence the trading-pit nickname “Gas Vegas!” While it may seem like a roll of the dice to some, natural gas is a critical member of the commodities complex and can generate solid returns for investors who can navigate its volatility.

After reaching decade-high prices in 2006, natural gas prices have been on a downward and volatile trend. Earlier this year, prices reached a 10-year low of $1.90/mbtu. Hydraulic fracturing, or “fracking,” is fueling this historical low price. These technological improvements allow companies to extract previously unreachable deposits sustaining a years-long production boom that has been most prodigious in the U.S. This remarkable energy boom has greatly depressed prices.

However, the market reached such a low that it almost became inevitable to see a price rebound, especially when producers began to massively cut back on output. As they reined in supply, prices staged a rally over the last quarter to settle at $2.69/mbtu, a 42 percent price rally in a matter of weeks.

Natural Gas Market Outlook

While prices have recovered significantly since the $1.90/mmbtu reached in April, they are still down almost 10 percent for the year. The Commodity Investor believes there are good returns to be generated in this market, but that an aggressive and active trading strategy is required.

Natural gas is not for the buy-and-hold investor. Price swings can be violent and sudden. However, traders who are ready to monitor the market regularly can post some solid gains in this market.

The way I see the market is that there is significant momentum that will push prices higher in the medium and short term. First of all, the industry has adopted a policy of “sustainable output,” which means there’s a collective decision to keep supply tight. This came as a direct result of the drastic oversupply that caused the price collapse in the first place.

Secondly, we’re currently entering the summer season, which has traditionally been bullish for prices. And this summer is no exception. Already, demand for power generation—which accounts for more than 35 percent of natural gas use—is up relative to last year. More Americans are cranking up their air conditioners, increasing demand.

Thirdly, there are some supply disruptions coming out of the Gulf of Mexico, an important supply-and-export region, posed by the hurricane season. Already, Hurricane Debby is expected to hit Florida at some point this month, forcing producers to shut down facilities due to safety reasons.

Finally, many electric utilities have been switching from coal to natural gas. This trend is not only being driven by pricing, since natural gas prices are at historic lows, but it’s also being driven by environmental concerns since natural gas is a much cleaner-burning fuel than coal.

Therefore, we’re seeing several bullish factors that are pushing up demand for this key commodity along with some serious supply-side disruptions. As a result, the market is indicating that prices should go higher and could reach $3/mmbtu before the summer is over.