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Natural Gas Stocks Are Saying the Bottom Is In – Or at Least It’s Close

The natural gas inventory number was very bearish for last week, yet the NYMEX natural gas price itself in the U.S. was only down a penny – at Henry Hub in Louisiana it was actually up 4 cents – and Encana (ECA:TSX, ECA:NYSE) rose 2.3% to US$44.55.

ECA is the bellwether North American gas stock.  If you want to know where gas prices are going in the future, that is the stock to watch. Encana has a lot of natural gas production in both Canada and the US.

This is a bullish sign for natural gas stocks. On a bullish natural gas scale of 1-10, I have just moved from a 2 to a 5.

The EIA in the US estimated there was a net injection of 3 bcf (billion cubic feet) of gas into storage last week, which compares to a 36 bcf withdrawal during the same week last year, and a five year average of 63 bcf withdrawal for this week.  The average analyst guess was an 11 bcf withdrawal.

Thursday March 26 should have been a bloodbath for natgas prices and stocks.  But it wasn’t.  Canadian gas prices tanked 10%, or 40 cents on the news. Stocks that are strictly Canadian production did not fare as well as Encana.  But the North American natural gas market is integrated, so I believe ECA’s performance today to be good for everybody.

Regular readers know I am one of the biggest bears on natural gas through 2009 and even part of 2010.  But I’ve learned you don’t argue with Mr. Market.  He is only right 100% of the time.  Mr. Market said today that natural gas prices and stocks are closer to putting in their lows than I believe.

Natural gas prices in the North America jumped 10-15% during the 10 days I was snorkelling in Mexico. I would suggest that move was mostly in sympathy with the move in oil prices, and the rig count from oilfields service company Baker Hughes repeating a now familiar theme – there are far less drill rigs searching for natural gas than previous years.

The Western Canadian Rig Count (oil and gas) at March 24 was 132, vs. 230 the same time last year and vs. a five year average of 381.  US gas rigs at March 20 were 857 vs. 1433 the same time last year.  The five year average is 1268. Less rigs means less gas produced in the future – though we have yet to see any meaningful drop in production compared to the decimation of demand.

Also, the number of horizontal drilling (HD) rigs has only recently started to decline. Their use is down 10% so far this year compared to 41% down for all rigs of North America.  HD rigs were actually UP by 4 last week.  That’s not bullish.

So what does this mean for retail investors?

There are still lots of macro-economic (recession) and industry specific (glut of low cost production, huge amounts of gas in storage) reasons that say fundamentally, gas prices and stocks should stay low – possibly for a long time. Even if gas goes to $5 again, many natgas producers have costs and debt levels high enough that they will produce precious little free cash flow.

I think oil prices are about to have a pullback – even if it’s just to US$50/barrel.  But Encana’s stock today is saying that natural gas prices might not pullback – or at least very little.

I don’t want to read too much into ECA – it is just in the middle of its trading range and does not break out until US$55, at which time it would cross its 200 day moving average at the same time as breaking out of its consolidation pattern.  But it could be significant that it did not break through its lows of last October during the recent natgas price drop to $3.90/mcf.

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