Weird weather and a supply glut have driven natural gas futures down to two-year lows
After falling to two-year lows, natural gas may be staging a rebound.
Bloomberg reported on December 26 that natural gas futures dipped below $3 per million BTUs on the New York Mercantile Exchange (but closed just slightly above), the lowest level seen in intraday trading since 2012.
Bloomberg attributes this bearishness in part to unseasonably warm weather, but high inventories are an even bigger overhang. If cooler temperatures are ahead, they could help boost demand and trigger a rebound. The bigger question for investors is: when will the demand and supply imbalance be resolved?
Excess natural gas supply
Natural gas is a byproduct of oil. As oil prices fall, shale oil producers may cut output, too, implying an eventual drop in the supply of natural gas. In the near term, expect volatility for producers of natural gas. Tax-loss selling and uncertainty in gas prices may hurt companies like Linn Energy (LINE) and Chesapeake Energy (CHK):
In an earnings call, Linn CEO Mark Ellis reported that 48 percent of the company’s production in Q3 2014 was natural gas. EVP Kolja Rockov added that the firm hedged from 90 to 100 percent between 2013 and 2016 through the use of swaps and puts.
Chesapeake CFO Nick Dell’Osso explained in a Q3 earnings call that the company has adjusted to commodity pricing for the rest of the year, actually increasing its expected natural gas differentials by $0.05. The “differential” in this case is made up of two components: basis, which is the field price discount to Henry Hub pricing, and non-basis, which includes gathering, transportation, processing and marketing costs.
Last quarter, Chesapeake’s production was split between 70 percent gas and 30 percent oil. Even though the price for both commodities is falling, the firm will likely be opportunistic in the coming year. Acquisitions and developments for current assets should position Chesapeake for growth in the long term.
Investors will not find it easy to pick the “bottom” in natural gas. The best thing to do to gain exposure in the sector is to start a small position and then average in. Eventually, prices will improve, and stock prices for firms like Chesapeake and Linn Energy should follow.
Click on the interactive chart to view data over time.
1. Chesapeake Energy Corporation (CHK, Earnings, Analysts, Financials): Engages in the acquisition, development, exploration, and production of natural gas and oil properties in the United States. Market cap at $13.11B, most recent closing price at $19.71.
2. Linn Energy, LLC (LINE, Earnings, Analysts, Financials): Engages in the development and acquisition of oil and gas properties in the United States. Market cap at $3.60B, most recent closing price at $10.85.
(List compiled by Chris Lau. Monthly returns data sourced from Zacks Investment Research, all other data sourced from Finviz.)
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