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.)

Ziff Energy is one of the largest and most respected oil and gas global consulting firms.  They just issued a 7 page news release with great statistics, great charts and cartoons that outline very clearly how much money Canadian gas producers are losing for every mcf (million cubic feet of gas) they produce at these low prices.

While it is a Canadian story, much of the same data holds true in the US – except US gas does have a lower cost base, says Ziff.

(Though a couple research analysts from a prominent oil & gas securities firm in Calgary recently made a presentation in which they showed their analysis of financial statements of both US and Canadian gas producers – and there was almost no difference in costs.)

Here is the link to their release. I had to read it several times to take it all in: http://tinyurl.com/mphn2h

Investors should overweight natural gas stocks in their portfolio right now, says a specialized oil and gas brokerage firm in Calgary, Alberta.

In a June 4 report, Tristone Capital says investors who wait to invest in natural gas stocks until the natural gas commodity price bottom in late summer – and they hold out the potential for US$3 gas or less – will miss out on a lot of capital gains.

It is the loudest bold call yet from financial industry I have seen yet this year on natural gas. Essentially, they are saying the bottom is in on natural gas stocks. They see an imminent supply decline, starting in July and accelerating quickly, because the North American rig count has dropped so much.

The natural gas rig count has gone from 1600 a year ago to 700 today in the US.

Tristone estimates the natural gas market is now 2-3 bcf/d (billion cubic feet per day) over supplied, but they expect gas production to fall by over 500 mmcf/d per month between now and the new year, with supply down 5.5 bcf/d by late Q1 2010 and 7 bcf/d by next spring.

Just like OPEC, that will take a lot of discipline by the many natural gas producers in the industry, particularly the juniors and intermediates that are cash flow starved and near their debt limits.
Tristone is forecasting a $6.75/mcf NYMEX gas price for 2010.

As yet, the drastically lower rig count in the US has not meant a drop in natural gas supply. The reason is that the number of rigs in the 3 prolific US shale gas plays – Haynesville, Marcellus and Fayetteville – is still increasing. So the newest, most productive rigs are active in the most productive formations, and delaying the supply drop, the report says.
Better rigs and more productive formations has increased the efficiency of rigs some 30%, Tristone adds, saying the average rig produced 9.7 mmcf/d at the beginning of 2007, and that’s up to 12.5 mmcf/d today.
But they contend the supply drop will happen, and soon.
The charts on natural gas stocks have been saying this for several weeks, as I showed on the previous article on Storm Exploration (SEO-TSX). And other brokerage firms have said the drastic rig drop will result in a sharp sudden increase of natural gas prices when the supply decline finally begins in earnest.
So if you believe this theory, in which natural gas stocks should you invest? Tristone says the senior gas stocks are fully valued, and the mid-caps are the best buys now.
I will outline some of the natural gas stocks in my portfolio in one of the first issues of my newsletter. I hope to be offering my subscription service for the investment newsletter by the third week of June.

Prologue-Keith Schaefer

Natural gas prices continue to bounce on the bottom of their recent price range, yet natural gas stocks charts are looking bullish – which means the market really does believe that the sharply lower rig counts across North America will mean a (sharp?) increase in natural gas prices sometime later in 2009.

Storm Exploration is 92% gas, and is consistently one of the top recommendations of the many research reports I read weekly from Canadian brokerage firms.   Production is focused on the Montney tight gas play in British Columbia and Alberta. It has one of the lowest finding costs for oil and gas in the industry.  Underneath Brian’s technical analysis, I have included the highlights directly from their latest quarterly.

Storm is one of a handful of natural gas producers, with a track record of success (mgmt has built and sold companies before), that  investors should be tracking if they believe natural gas prices will rise this year.

Brian nor I own stock in Storm; he just finds charts he likes and does the technical analysis.  Storm is not a portfolio purchase for Oil and Gas Investments Bulletin.  I enjoy his write-ups and hope readers do as well.

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The stock chart for Storm Exploration Inc. (SEO-TSX, $13.58) looks bullish with a recent breakout from a downward price channel marked by the blue dashed lines in the chart below.  Importantly, the breakout achieved a minimum 10 per cent move above the top dashed line and was accompanied by increased volume, which confirmed the breakout.

Storm’s share price faces resistance at about $14.25, which is the price level marked with the green line.  The share price has started to consolidate around the $13 to $13.50 level and should find support at the top of the downward price channel, currently at about $12.

Operating costs are still coming down in North American natural gas and oil plays.  This isn’t showing up as reduced all-in costs on the financial statements of these energy producers just yet, but it will. 

Costs are lowering for two reasons.  One is demand destruction, which has cut in half the number of rigs drilling for oil and gas in North America.  This has meant that rig rates have also dropped – energy executives are saying they see 20%-35% cost reductions year over year.  Lower drilling costs have an obvious impact on profitability.

The second is that companies in both the US and Canada are figuring out how to properly frac these new unconventional gas plays – both tight gas and shale gas. 

There was a 20 year learning curve to get the first shale play, the Barnett Shale in Texas, into production.  (It’s actually a great story of petrochemical engineering and sleuthing  that I will share with you all another time.) Well, that learning curve is still happening.  Production out of these long horizontal wells is getting better in ALL the unconventional gas plays (and oil plays) in North America. 

Chesapeake (CHK-NYSE) is the largest natural gas producer in the US.  They announced in their latest quarterly that they have a new well producing 9.6 million cubic feet of natural gas (mmcfe) – and associated liquids – per day during the past 30 days, which they believe to be the highest 30 day  rate of any well in the entire Barnett Shale play to date.