The case for natural gas

Big Mike is back!

This week I’ve been thinking about natural gas. Two factors are probably scaring away a lot of investors from natural gas stocks: (1) record high storage; and (2) the XNG (AMEX Natural Gas Index) is only slightly off its all time high price.

The record high storage masks the coming natural gas crisis. Production of natural gas has actually been declining, and the hurricanes from last year permanently took some natural gas production off line. However last winter was ridiculously warm, and the high domestic gas prices have caused demand destruction; natural gas intensive industries have moved to other countries with lower gas prices, never to return. Because of the warm winter and the demand destruction, it looks like the U.S. is well supplied with natural gas, but it’s really not.

But the sign of the coming gas shortage can be seen in the storage withdrawals of this summer. This is the first time there has ever been a draw from storage during the summer. The increasing reliance on natural gas-fired electric plants has finally revealed itself in the storage reports.

The increasing U.S. population means that the square footage of buildings that need to be heated in the winter (as well as cooled in the summer) will also be increasing.

Where will the new production come from to meet future demand? Look at the U.S. E.I.A. production data and you will see that production has been nearly flat since 1996 despite rising prices.

Increasing demand with no corresponding increase in production guarantees higher natural gas prices in the future. Another bad hurricane season or a cold winter would result in a very quick return on investments in natural gas companies.

Comments

[Timbo]

I agree completely. A few other factors to consider are:

1. Increasing use of natural gas (NG) for production of syncrude from tarsands, in Alberta.

2. Growth in U.S. manufacturing.

3. Slow growth in ability to import LNG.

For (1), there has been a great deal of investment in the exploitation of the Alberta tar sands. There are two ways to get the tar out of the tar sands. In the first, the tar sand is mined and dumped into a big vat of warm soapy water, where the tar separates from the sand and is skimmed off. The water is typically heated by an NG burner, and some of the mining equipment may be run by electricity that is generated from NG.

The other way is steam assisted gravity drainage. In this method, first and second pipes are put into the earth so that they extend horizontally under a tar sand deposit. Steam is injected through the first pipe, so that it can rise through the deposit, decreasing the viscosity of the bitumen, which then flows downward into the second pipe. In practice many first and second pipe pairs are placed underneath a large deposit and worked all at once. Typically, a lot of NG is used to make the steam.

Whichever method is used to harvest the bitumen, more natural gas is used to turn it into synthetic crude. Bitumen is made up of long hydrocarbon molecules having two hydrogen atoms for each of the carbon atom, except for those at either end of the chain, which each have three hydrogens attached. Consequently, the longer the chain, the lower the hydrogen to carbon ratio. When the long chains are broken to create a more easily useable liquid, methane (NG) is added, as it is very hydrogen rich. So if you fill your tank with gasoline made ultimately from bitumen, it is also part NG.

For (2), with the housing market rapidly deteriorating, either another part of the economy will grow to pick up the slack, or this country is going to slide into a very serious recession. A great number of loan officers, construction workers, title searchers and real estate agents have prospered during the lengthy housing and consumption boom over the past four years. Now we are seeing the collapse of that entire industry. Either the fed needs to cut interest rates, or manufacturing must grow, perhaps due to a drop in the value of the dollar, which I hope occurs sson, with or without a fed rate cut. Manufacturing uses electricity, which will be generated with NG.

For (3), go figure: http://www.cheniere.com/LNG/LNG_terminal_construction.shtml
They were supposed to be a little further along at this point. It is just hard to know when our capacity to import LNG will actually increase substantially.

So, add it all up, and I have to agree with you. Sure, we might end the fill season with more than can be put into storage, but not if we have a few good hurricanes. And who knows if the coming winter will be warm. Yes, I believe there is global warming, but the weather is always hard to predict. Further, we don't have to match last winters very high price of over $14/(million btu) to be able to make money going long in NG.

Do you invest directly through a commodities account??

[The Engineer]

Good analysis. In addition to electricity and tar sands, clean air regs are driving NG demand. Reformulated gas requires hydrotreating, which uses vast quantities of NG to create hydrogen. Also, desulphurizing fuel requires hydrotreating as well, and there is a big new mandate to remove the sulphur from diesel.

Also, there are new clean air regs for diesel engines that may not be achievable with available technology. One solution would be to replace diesel engines with NG burning ones. Can you imagine the price of NG if every OTR truck in America burned NG instead of diesel?

[J.S.]

with commodity prices dropping even further since the posting of this blog, seems like everyone is jumping off the commodities bandwagon including Morgan Stanley's chief global economist, who is stating that the bull run of commodities is done. but like you, big Mike, I think he's wrong. I particularly like natural gas for all the reasons you mention. People hate things, they're at a low, people will always need them (natural gas, so you buy when it's at its low. I particularly like Chesapeake Energy (CHK) as my natural gas play. What do you think about CHK?