Three Forces That Could Ignite Natural Gas

Despite being sidelined for the most of the first half of the year, weather conditions, supply and demand imbalances, and Congress could lead to an opportunity in natural gas.

According to the National Weather Service, the next few months are expected to be warmer than usual, with average temperatures being above normal by 2 to 3 degrees across the nation.  What this means is that consumers will likely run their electric powered air conditioners more often and for longer periods of time.  This further translates to increased demand for electricity, which has a domino effect and increases demand for natural gas. 

On the supply forefront, an extremely active Hurricane season, the offshore drilling moratorium and the decline in active drilling rigs over the last few years is expected to cut production of the commodity in the Gulf of Mexico by nearly 10%.  Weather experts suggest that the current Hurricane season could produce as many as 23 named storms, 14 hurricanes and 7 major hurricanes in the Atlantic Basin, more than double the seasonal and historical averages.  This could potentially devastate natural gas production and push supply and demand forces out of whack. 

To further add to supply worries, the announced offshore drilling moratorium is anticipated to cut Gulf of Mexico production by an average of 0.05 Bcf/d for the rest of the year.  Another supply constraint that could provide price support to natural gas is the recent downward revision of imported liquefied natural gas (LNG) by the Energy Information Agency (EIA).  The EIA expects total imports of LNG to grow, but likely be diverted to Europe and Asia due to higher prices in those regions. 

As for demand of natural gas, an increase for the remainder of the year is expected, in particularly in the industrial sector.  It is expected that consumption will increase by nearly 7.5% in the industrial sector for the entire year. 

The last force that could give positive price support to natural gas is Congress.  On Tuesday, Senate Democrats outlined a $15 billion energy bill which would incentives the use of natural-gas trucks through rebates.  The bill proposes rebates of $10,000 to $64,000 per truck and provides grants to pay for natural gas fueling stations and loans to U.S. manufacturers that build natural-gas powered trucks.  If this bill makes it passed Republicans, it could push demand for natural gas as a source of fuel much higher.

Some plays on natural gas include:

  • United States Natural Gas Fund (UNG), which enables one to gain access to natural gas through futures contracts.  UNG closed at $8.11 on Thursday.
  • First Trust ISE-Revere Natural Gas (FCG), which holds 30 different companies that are involved in natural gas. Some of its holdings include Exxon Mobil (XOM), Questar Corp (STR) and Total SA (TOT).  FCG closed at $15.99 on Thursday.
  • iShares Dow Jones US Oil & Gas Ex Index (IEO), which includes numerous holdings of companies which are involved in the exploration and production of natural gas.  Some of its holdings include Chesapeake Energy (CHK), Devon Energy (DVN) and Apache Corp (APA).  IEO closed at $50.19 on Thursday.
  • iPath Dow Jones AIG Natural Gas ETN (GAZ), which is an unsecured, unsubordinated debt security that seeks to replicate the performance of the Dow Jones-UBS Natural Gas Total Return Sub-Index, which is composed of Henry Hub Natural Gas futures contracts. GAZ closed at $10.93 on Thursday.

Although an opportunity could exist in natural gas, it is important to consider the enhanced the volatility of the commodity.  To help protect against this, the use of an exit strategy which identifies specific price points at which downward price pressure is likely to occur is important.

According to the latest data at www.SmartStops.net, these price points are as follows: UNG at $7.35; FCG at $15.36; IEO at $48.39; GAZ at $10.29.  These price points change on a daily basis and are reflective of market volatility. 

Disclosure: No Positions

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