Taking Their Chances in the Spot Market… Later
Natural gas prices in Canada are so low that end users are now trying to seduce producers to hedge, so they can lock in longer term low prices. But few producers are keen to lock in long term losses.
RBC, Canada’s largest brokerage firm, suggested in a weekly comment that producers still have many reasons to hedge at $3.27 a gigajoule (GJ) now, and $4.11/GJ in April 2011. For context, the full-cycle cost for new gas in North America is $5.60/mmcf and in Canada is $6.85/mmcf, according to independent analysts Ziff Energy. So producers would be selling at a significant loss.
But some quick calls to the energy desks of the major Canadian firms showed that few producers are biting, and even one of my contacts at RBC said these “hedging strategies are geared more towards the end-user market; the end users are trying to lock in really good prices. But nobody’s hedging.”
RBC lists several potential reasons for hedging, which often mirror the Ziff Energy white paper from June 2010 on the state of Canadian natural gas (a GREAT read – not too technical – www.ziffenergy.com/download/papers/cdn_gas_crossroads.pdf.)
1. Strengthening Canadian Dollar
2. US Production Growth
3. Reduced Canadian Imports
4. Heightened Pipeline Delivery Competition in the US
5. Abundance of Canadian Storage
6. Material Expansion of Canadian Shale Gas Production
7. Growth in Marcellus Shale Gas Production – Production has increased by over 1 bcf/d since January 2010
That’s a big list! And it’s not good news for producers or their investors – especially the junior ones who either have high gas weightings or are close to their debt limit.
But despite producers losing money on every mmcf out of the ground, some may be inclined to hedge, says Ralph Glass of AJM Consultants.
“The bigger producers are still drilling and they can afford to (hedge); it’s part of their long term plan and their economics of scale allow it. The only advantage I can see is that if you’re making positive cash flow at $3.50/mmcf, this gives you stability to hang in for one more year. But it’s not an investment strategy.”
He added even small producers may consider it: “A small producer that has limited cash flow cannot afford to pay for capacity costs without actually producing the volumes.” This means they may have “take or pay” like provisions, where the producer must pay the pipeline companies their transportation tolls even if they don’t produce the gas.
For producers, it comes down to the same issue it always does – are prices going lower or higher? By not hedging, major producers are saying that despite all the gloomy market data, they see prices stable or higher.
Long term dated future gas prices are now below $5/mmcf for a full two years out now. With such a low, and flat futures pricing curve, producers are saying they would rather take their chances in the spot market then, rather than lock in losses now.
P.S. One of the most-asked questions I get from my readers is, “When should I invest in natural gas?” Follow the link to read my response.