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Natural Gas Prices Remain Firm Despite Bearish News

Natural gas prices stayed remarkably strong this week, despite two very bearish developments. This is actually bullish, when a market won’t go down on bad news. Yet I still think this downturn in natural gas prices could be longer than people think. I am not buying natural gas stocks right now.

The bearish points this week were:

  • 1) An injection into storage this week of 114 bcf, the fourth week in a row of 100 bcf + injections. (I don’t think this has ever happened before.) Expectations were for 105 bcf, and almost double last year’s injection for the same week.
  • 2) The rig counts in North America turned slightly higher this week, for the first time in 2009. In the regular Friday report from Baker Hughes, US gas rigs were up 6 over last week, and horizontal rigs were up 20 – which deliver a lot more gas than verticals. Canadian rigs had a much bigger percentage jump, up 35 to 143. About 66% of all rigs in Canada drill for gas (though this number is surely going lower). Of course, these numbers all half of what they were a year ago.

Despite this, natural gas prices for the July NYMEX contract stayed above $4, closing at $4.09. Henry Hub prices were up 4.5% this week. Canadian AECO hub prices closed at $3.47.

It’s clear that investors remain focused on the expected supply drop in natural gas being severe, and causing a rapid ascent in natural gas prices later this summer. And sentiment is increasing that prices must rise to the $8/mcf range to turn a profit on “full cycle” costs (not just operating costs, but finding costs and land acquisition costs etc.)

(I don’t know how much of that “full cycle” argument to believe. Most of those high costs on the new, very productive tight and shale gas plays come from the high prices companies paid for the land, before the crash. Costs had skyrocketed. And those are now sunk costs. The reality is that the gas coming from those properties may never produce a “full cycle” return because of the cost structure in the industry at the time and the high land prices generated by mania surrounding shale / tight gas. As this gas glut persists, operating costs will continue downward, and once land prices do as well, I see full cycle costs going a lot lower – but not for a year or two.)

I think there are a couple points that could prolong this natural gas price downturn longer than people think:

1. Banks which hold the (rather significant) debt for the energy companies did not dramatically cut back on credit lines for the producers this year, despite a big drop in natural gas prices. So even though many natural gas producers are operating close to their debt limit, they have not yet been forced to make the tough choices to survive  (sell assets, or sell the company).  This painful process of keeping alive a dying patient will now be drawn out longer than normal.  (Asset sales are increasing though – see the $176 million deal that Advantage Energy Trust (AVN-UN:TSX) sold some of their natgas to NuVista (NVA-TSX).)

2. New junior oil and gas companies cannot get financed. So when two or more companies merge, one management team is out of a job. And in this market, they won’t get a new one for awhile.  Nobody wants to lose their job, so management of these producers have no incentive to sell or merge.

3. The banks are saying – I have two sick patients, each having 80% of their debt drawn, and they want to create one larger sick patient with 80% of its debt drawn….no thanks.

4. Most junior and perhaps even some intermediate companies are receiving very little cash flow right now, yet they still have some fixed costs – like regular interests payments on their debt. For these producers, even a little cash flow is better than none. So I think they will be hesitant to turn off the tap (shut in production), no matter how the small the drip.

5. And again, LNG is a wild card. If Asian demand doesn’t pick up soon, the global fleet could be coming to North America and keeping prices here suppressed.

Most gas stocks and the energy sub-indexes in the US and Canada are rolling over to the negative now. After the good run up in natural gas stocks this spring, gas prices had to start showing some signs of recovery, or gas stocks would turn lower. It looks like they’re turning lower. Only the most favoured mid-tier producers like Storm (SEO-TSX) and Celtic Exploration (CLT-TSX) are still in consolidation patterns. (I own none of the companies mentioned in this article.)

I’ll be watching the natural gas market and my favourite gas stocks closely for a potential summer entry. None of my current portfolio purchases are gas weighted. Both the charts and the fundamentals tell me I should wait.



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