August is often one of the best months to buy natural gas stocks; gas prices and the commodities stocks overall are at a low.  There is often (but not last year!) a run up in gas prices in the fall – and stocks follow – as heating homes across North America use natural gas.

Every year at this time I think, what gas stocks should I buy for the fall run.  Last year both Peyto (PEY-TSX) and Donnybrook (DEI-TSXv) were two OGIB gas picks that had great fall runs in a weak gas market.  Another OGIB pick, Cinch Energy (CNH-TSX), was just taken out by Tourmaline (TOU-TSX) at a huge premium.

I’ll take a look at some of the bearish and bullish points for gas this fall, and offer up an investment idea for you to research at the end of the article.

The market is still divided on gas prices over the next year.  Most analysts and investors are in the bearish camp, citing the fact that gas production in the US is 4 bcf/d more today than a year ago.

But Calgary based energy analyst Peter Tertzakian says volume growth is slowing, as 2010 dry gas production was increasing more than 6 bcf/d over 2009.  And technical analyst Bill Carrigan still sees higher gas prices later this year that will be sustained.

One intriguing and potentially bullish factor for gas this year might be from securities regulators, not geologists.

Allen Brooks of PPHB Energy Investment Banking in Houston writes a wonderful and reasoned monthly column, and in his latest he mentioned a couple anecdotes that could suggest higher regulation of shale gas is coming – which could increase costs, but obviously it’s impossible to say how much.

Anecdote #1. the American securities regulator, the SEC, recently asked a shale gas producer going public to disclose how much frack fluid they were using per well, and what “additional chemicals” are being used by them.  But there is no law that says producers have to do that – leading to speculation (and it’s only that) that the Environmental Protection Agency (EPA) was behind the inquiry.

Anecdote #2. the Securities and Exchange Commission (SEC) has served subpoenas on a number of gas shale producers. According to a law firm, the subpoenas seek:

• documents and information regarding the actual performance of shale gas wells against forecasted or projected performance
• the propriety of decline curves used for the wells
• the calculation and public disclosure of full-cycle margins

Brooks concludes that he doesn’t expect a Gulf of Mexico style drilling ban on fracking in the US, but more regulation will mean more costs which could lead to higher prices, and less natural gas drilling.

Brooks also points out an interesting statistic for the giant Marcellus shale play in New England that the natural gas bulls could use.  He says projections on future production for the Marcellus have increased dramatically between 2009 to 2011, with much of that increase based on future technology improvements that will increase production per well.

But the reality is that results are being extrapolated across the entire acreage of the play, and like most plays, production has sweet spots that are only a fraction of the play – intimating that the chances of those high projections coming true are slim. This again would be positive for the bulls.

However these are all ifs and maybes.  There is some concrete data that the bulls can point to– natural gas prices have held up better this spring and summer than most people (including me) expected.  And due to a very cold spring in Canada and a very hot summer in the US, storage levels for gas have gone from record high late last year to just below the five year average (though the storage gap has been closing for seven weeks in a row and if super hot weather doesn’t continue to push air-conditioning use…).

And data released by the US Energy Information Administration (EIA) does point to a relative flattening of gas production.  US production was down 0.2 bcf/d in May from April – but as mentioned above, that is still a 4 bcf/d or 6.8% increase Year over Year (YoY).

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And that’s where the bulls get stopped—at least for now.  Because whatever arguments they have that shale gas wells will deplete fast and early and likely be shut in ahead of projections (their main point), right now incremental production is being coming onstream to meet demand as needed.

Bentek Energy estimated that Aug 2 was a record 62 bcf production from the US, a 1.1 bcf increase over estimated July production levels.

Calgary-based Union Securities analyst Warren Verbonac noted January and February gas futures – the highest priced months of the year usually – are only 35 cents higher than current prices, indicating the market’s confidence that whatever Old Man Winter throws at North America this year, the producers can fill demand.

The gas rig count has been stubbornly high, only retreating 6% this year so far to 877 rigs.  While the rig count declines, production increases, as the industry continues to improve its fracking methods and making up for any decline in the actual number of rigs drilling.

And the hurricane seasonality no longer affects gas prices as it used to, due to all the onshore shale plays now (though Louisiana has the fastest growing gas production in the US).

There are a couple other bullish points for gas.  Canadian production continues to decline as everyone up here drills for oil.  And in the US the trend towards liquid rich gas continues, where IP rates are generally much lower than for dry gas.  I expect the US to become a big gas exporter as LNG permits are issued and facilities built – but that’s years away.

To me, the good news is that prices didn’t collapse to sub-$2/mcf this summer, and storage has been depleted so that (especially for Canadians) a collapse in prices is unlikely.  But I don’t see gas moving much higher this fall to have any significant impact on producers’ cash flows.  I own one junior and one intermediate – Donnybrook and Peyto – and for now I will stick with those.  Painted Pony is also a great call on gas with its large Montney position and it has a large Bakken oil land block to back it up.  Right now I don’t see myself buying any other gas stocks for this year’s autumn gas market.

But there are still several Canadian juniors and intermediates making good cash flow at current Canadian prices, and to me represent one of the best calls on gas.  These are the wet gas, or liquid rich producers in Alberta’s Montney formation.  They have been some of the best performing stocks in the Canadian energy patch this year – especially companies like Celtic (CLT-TSX) and Trilogy Energy (TET-TSX) which were the first to produce natural gas from the Duvernay source rock in the Montney.  (Source rock=shale most of the time)

One junior stock that has also done well but may still have room to run is Cequence Energy (CQE-TSX).  They are focused in an area of the Montney called Simonette.  One of my favourite juniors, Donnybrook, is their partner on some wells there.  Cequence has a large drilling inventory, low costs and liquids rich gas production.  The higher value-add liquids allow them to have positive cash flow at $2/mcf at Simonette.

Cequence management has been able to increase production from 1300 boe to 8100 boe in 18 months, through one merger and organic growth.  They expect to exit this year with 10,000 boe/d production.  Note that they are raising $50 million right now.   Web site: www.cequence-energy.com

Finally, for the record, today’s natural gas price is $4 U.S. and $3.40 Canada.

DISCLOSURE: I own no stock in Cequence. I do own Donnybrook and Peyto.