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With Conflicting Signals on Natural Gas and Oil Stocks, We Sit

I am busy writing my first issue, but wanted to make a couple quick comments on the oil and gas markets.  The market is divided on whether this rally can continue, in both the Dow Jones and in oil. For the Dow, I see sentiment shifting from a “Sell in May and Go Away” mode to a “This Stimulus Rally has Legs Until At Least September”.

Oil and natural gas are in similar positions – prices are rising at a time when the world is overflowing with supply. Should the market sentiment shift to focus more on future supply as opposed to future demand, energy stocks would have a definite swoon.

Investors should note that the Canadian dollar is also rapidly rising, (or rather, the US dollar is rapidly declining) so net cash flows to TSX publicly traded companies are not improving as much as one might think. 

Despite charts breaking out on some of my favourite stocks, and some of the energy indexes, I am not a buyer here – but not a seller, either.  I have some stop losses in to protect profits.  All the chart breakouts have been on declining volumes, which is not a bullish sign.  I am waiting to buy some of my favourite names – which I will mention in my first issue.

Natural gas prices have rebounded 10% in the last two trading days, as the market continues to be focused on an improving economy and rapidly falling rig counts.  I think the rig counts will be a factor but farther down the road than people think – likely 2010.  The reason is that horizontal wells have so much more production, that it would take a lot more wells to come offstream to make a meaningful impact with the declining demand that North America has experienced.

Bulls point to the huge decline rates that horizontal wells have – and that’s true.  But what I see is that even after a 70% first year decline, the remaining production declines (called the “tails”) are a very normal 20%, and take on the production run of a regular vertical well.  Except now, the capital has been (almost?) paid back and the wells can produce positive cash flow at a much reduced price.

Also, notice that last week, the total rig counts between the big two shale gas producing states, Louisiana and Texas, did not go down. One was up 3 rigs, one was down 3 rigs.

After this latest 10% bump up in natgas prices – and some of the natgas stocks – I am being very cautious about buying anything. And while caution is the word, I still smell the pent up buying on natgas stocks, which could have a 20% further bump up should even one week of inventory levels not meet expectations; i.e. injection into storage be less than expected.  I will be a seller that or the following day.

The market forces for natural gas are strong – there is A LOT of Liquid Natural Gas that could come here. Eventually, rig counts will cause a BIG decline in production.  I look into the future and see no clear trend.  And I don’t like to bet.

However, investors care not.  The Amex Natural Gas Index ($XNG-TSX) and the S&P/TSX Capped Energy Index (TITTEN-TSX)both broke through their 200 day moving average today, and through the top of the channel they had been in for six month – though on declining volumes.

Two of my favourite energy stocks epitomize this trend – Celtic Exploration (CLT:TSX) and Petrobank Energy (PBG-TSX) have broken out on their stock charts – a good sign – but on declining volumes – a bad sign.  But when you by low cost producers with good growth profiles, you can afford to be patient.

One of the hardest things for retail investors to do is sit on cash.  But in the face of conflicting signals, that’s what I’m doing now.



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