WSJ Calls The Bottom In Natural Gas

One day, probably in the not so distant future, Spencer Jakab of the Wall Street Journal will probably regret suggesting that natural gas prices may go negative, as he did in today’s article “Why Natural-Gas Prices Could Fade to Red”. It’s an attention grabbing headline, but is likely to be better known some time in the future when natural gas has bounced and Mr. Jakab’s piece comes to be remembered as the time when the very last sellers showed up on the scene.

And of course natural gas fundamentals over the near term continue to look extremely poor, with a warm winter reducing the need to restock inventories during the shoulder months. Owning natural gas futures has been a terrible trade for anyone foolish enough to speculate that way, and there’s no near term bounce in sight.

But it’s not clear why anyone would pay to give away natural gas. It can be flared off or simply not produced if prices are unattractive. There’s also growing evidence that its cheap price is drawing utility demand for electricity generation while at the same time depressing demand for coal. In fact, the long term outlook is revealed by Kinder Morgan’s strategy (KMP). Their acquisition of El Paso (EP), expected to close in 2Q12, adds an extensive network of natural gas pipelines to KMP’s existing network as can be seen in the presentation they published when the acquisition was announced. Kinder Morgan expects increased movement of natural gas.

nd KMP is expecting increased exports of coal as domestic demand wanes.

Meanwhile, investing in companies drilling for natural gas hasn’t been nearly as painful as being long the commodity itself. Range Resources (RRC) for example, over the past twelve months has matched the return on the S&P500 (although it’s been more volatile). In round numbers, 5 TCFE (Trillion Cubic Feet Equivalent) of proved reserves provides a solid base for its $9BN market cap (if they earn $1 per MCF that’s worth $5BN) and they have ten times that in potential reserves. Their manageable debt (less than $2BN net of cash, or 45% of their total balance sheet capitalization) and low production costs means that the equity holders are unlikely to lose the company to the debt holders. Their increased production of NGLs (natural gas liquids) generates cashflow from an area with more buoyant demand. Owning operating assets, or equity in operating companies such s RRC is far better than going long the futures.

So remember today’s WSJ story – although Mr. Jakab does point out that in the long run low natural gas prices will create their own demand and likely selfr-correct, the article’s headline will almost assuredly be worth revisiting at some point in the future.