Friday, November 20, 2009

Natural Gas: Ride the U-Turn Up!


The writer being always interested in Natural Gas was watching with amazement as the pricing of this commodity tumbled over the course of 2008 to 2009. See the following chart for the precipitous drop:

Figure 1: Natural Gas Pricing in Past 3 Years. Note the drop from the peak of $13.69 in July 2008. Also note the sharp price reversal that started in September 2009. Source:

In the above chart, notice the highs in Summer of 2008 of $13 for Natural Gas. The chart shows the New York Merchantile Exchange (NYMEX) spot pricing at the Henry Hub in Louisiana. Approximately 50% of the US consumption passes close by to this centralized distribution point, so the pricing here sets a standard price for trading markets. The Natural Gas spot price slid uninterrupted until March 2009, when I started watching. Then the price churned sideways in Spring and Summer of 2009. From my tediousness in watching the churning, the writer missed the start of the run up at the beginning of September 2009. This trend reversion appeared to be part of the Gold, metals and commodities bull push up that began this fall at the beginning of September.

Then recently, on November 18, 2009, the writer caught the article by Sol Palha describing how Natural Gas may make a good long term play and I decided to capitalized upon this trend.

Situation Analysis

New Sources of Supply

Natural gas pricing is burdened with the tales of new discoveries of Natural Gas in shale rock formations. The stories relate that supplies with this new technology of sideways drilling will supply vast amounts of the neglected energy fuel for decades into the future. Also, there are other unconventional sources that new technology is bringing to the forefront such as Deep Natural Gas, Tight Natural Gas, Coal Bed Methane, Methane Hydrates and Geopressurized Zones. For a primer on these new sources see this Natural Gas Organization link.

Analysts are divided about the cheap gas potentials. At the Peak Oil Conference in Denver on October 13th, 2009, Energy Analyst Randy Udall stated, “The U.S. gas production peaked 35 years ago, and the roughly 10 percent jump in production over the last four years required doubling the drilling rate.”

Whatever the case may be, the writer believes the markets have already priced in all the theories of Natural Gas boom or bust into the pricing.

Economic Support for Higher Pricing
Though there is still wide spread concern about the robustness of the economic recovery and criticism about the recovery without jobs, the stock markets have clearly made a strong move up from March of 2009.

A leading indicator for the recovery is the pricing performance of the commodities upon which the economy is based. Examining the Continuous Commodities Index (CCI) gives one a good proxy for the leading edge of the economy’s behaviour as the index is composed of 19 raw materials used in industry. See the chart below for the calamitous drop of the CCI index in Summer of 2008 and the slow climb back this year.

Figure 2: The Commodities Research Bureau (CRB) Continuous Commodity Index (CCI) of 19 key commodities. Note the peak in July 2008, similar to Natural Gas (Natural Gas is 6% of this Index). Note that recovery for CCI started in December of 2008, while Natural Gas waited for Fall of 2009 to make any moves.

Comparing the Natural Gas NYMEX price chart to the above CCI chart, we see that the Commodities led the way, and that Natural Gas only started to move this Fall. This may stand to reason, as gas demand is cyclical annually and the demand season is just beginning to start with the onset of winter.

For further confirmation of the economy recovering, we examine the Baltic Dry Index. This is a shipping price index out of London, England which tracks the cost of international shipping of bulk cargoes. This is the follow on to the CCI as the cost of delivery of the commodities to the end users. The chart of the Baltic Dry Index below shows a bottom at the end of September 2009, with a sharp rise into October and November.

Figure 3: Baltic Dry Index of Shipping Costs. Note the bottom set at the end of September and the sharp rise into October and November.

From the commodities pricing behaviour and the rise in the Baltic Dry Index, the writer concludes that there are good supports for the idea that the recession has ended and that the recovery is on the way.

Annual Cycles for Domestic Natural Gas
Historically the gas prices are higher during the winter heating season as shown on the chart below.

Figure 4: NYMEX Natural Gas Price - 12 previous months. Note the Winter and Summer Pricing Cycles. Source:

The US Natural Gas distribution authorities purchase and store the gas underground in the Summer months and withdraw the gas for usage in the Winter months. The date for stopping the injection storage and for starting withdrawals for sales is creeping up on us; the start date may be during the week of November 23rd, 2009, dependent upon the weather. This annual pricing cycle for the winter heating season just adds further confidence to the trend reversal.

Natural Gas Bottoming and Trend Reversal
From the chart displayed in Figure 1, the Natural Gas price bottom was hit on September 4th , 2009at $2.62 and a sharp reversal happened. The price rocketed up to $5.83, reached on October 21st, 2009. Since then the price has eased off, settling just about the $4.50 range, presently.

This writer actively seeks value situations where a trend bottoms and a reversal is due. For Natural Gas, the bottom may have been reached in September already, and this November correction is merely a small pullback before a resumption in the up trend. This previous bottom, in the writer’s opinion makes the risks smaller, as the bottom has already been placed for Natural Gas.

For a second opinion, here is an interview with Robert Cooper, Acumen Captital Finance Partner, captured by Arjun Rudra, another Seeking Alpha contributor titled, “Cooper, Turnaround Happening for Natural Gas”.

Playing the Trend
There are many ways to play this trend. The Natural Gas industry has been battered by the year long slide in the commodity price, and one can pick through the litter for value. The writer is partial to large pipeline companies such as Enbridge (ENB) and Kinder Morgan (KMP), though they encompass more than just natural gas.

For further background and understanding about Natural Gas, a good Triology about Natural Gas was written by Joseph L. Shaefer, starting with “Natural Gas: America’s Energy Salvation”. For a discussion on the merits of some Natural Gas companies see “The Nine Best Natural Gas Oil Pipelines” and three top Natural Gas stocks “ Natural Gas Stocks: The Ultimate Form of Stored Solar Energy”.

Other methods of reaping gains in natural gas prices would be tracking ETFs. The most popular ETF, the United States Natural Gas Fund (UNG) has swelled their assets to over $4 Billion and causing distortions in the markets. UNG has also encountered issues with costs involved in rolling over their futures contracts. Here is a Seeking Alpha article by Lara Crigger explaining the differences between UNG and UNL, the newly launched ETF version intended to spread out the Natural Gas futures rollovers. Finally here is a guide to Natural Gas ETFs.

Leveraging the Trend for the Risk Amenable
Since the writer has a certain degree of confidence in the analysis and the possible U-turn coming, he is looking to maximize the possible gain. There is a leveraged two times fund named the Horizons BetaPro NYMEX Natural Gas Bull Plus ETF (HNU in Canada and HNUzf in the US) managed by Horizons BetaPro Exchange Traded Funds. As described by their originator:
“The HBP Bull+ ETFs and HBP Bear+ ETFs are designed to provide daily investment results, before fees and expenses, that correspond to double the daily performance, or double the inverse daily performance, respectively, of their specified underlying index or benchmark.”

The writer’s understanding of leveraged ETF’s is that the fund should perform satisfactorily if the trend is right, and moves directionally without much churning. The costs generated daily during the price churning will eat away at the gains. Also during a counter movement, the potential exists for a doubling of the leverage during the counter move, and thereby losses may be more than doubled.

Therefore, a heavy note of caution here is warranted as leveraged ETF’s are risky and come with a whole slew of these issues such as tracking errors, significantly higher expenses and daily returns not long term returns. Here is an older Seeking Alpha article detailing “The Case Against Leveraged ETFs”.

The HNU fund only tracks the domestic NYMEX spot price at the Henry Hub location. This limits the effects of other drivers of natural gas pricing and concentrates solely upon the supply and demand equation at the distribution point. See the chart following for the recent price action of the HNU ETF.

Figure 5: Horizons BetaPro NYMEX Natural Gas Bull Plus ETF. Note the Dolji at the end. Source

From examining the above chart, the bottom for HNU appears to be firming up with the two blue days ending on November 20, 2009.

The general economic climate is in the beginning stages of recovery. The recovery in commodities prices and the Dry Baltic shipping index gives support to the idea of recovery. Natural Gas pricing fell with everything else and was slower to recover having being impacted with a glut of new supplies and the summer season of lower demand. The bottom for Natural Gas prices was already set in September, 2009. Now that winter is looming, the seasonal demand and price adjustments should soon be having an impact. Whether the pricing moves up this week or later, the trend should be upwards for Natural Gas from here.

The writer holds a long position in HNU.

Marco G. November 20, 2009

Important Disclosure
The information and opinions contained within this document reflect the personal opinions and views of the author and should be view as information for thought and entertainment only. The author may from time to time have a position in any of the securities mentioned. Any material within should not be construed as accurate or reliable or be utilized as advice for investment or business purposes. Independent due diligence and discussions with one’s own investment and business advisor is strongly recommended. There are no guarantees of the accuracy or completeness of the information contained herein. These writing are not to be construed as an offer or solicitation with respect to the purchase or sale of any security or as an endorsement of any product or service. We do not receive or request compensation in any form in order to feature companies in this publication. It is prohibited to copy or redistribute this document to any type of third party without the express permission of the author. This document may be quoted, in context, provided proper credit is given.

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