Technical Analysis of natural gas ETF – UNG:NYSE

By
Keith Schaefer
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By Brian Hoffman, CPA, CA

Natural-gas prices have shown some strength recently, piggy-backing on higher oil prices.  Although last week’s higher than expected gas storage update is bearish in the short-term for natural-gas prices, the longer term outlook bodes well for significantly higher natural-gas prices.

Although oil prices will also probably pull-back from the recent run-up with the technical outlook turning bearish in the short-term if oil prices breach the US$50 support level, oil prices are likely to remain strong in the years ahead, which will help to support natural-gas prices.

Despite the current over-supply of natural-gas, the supply-demand situation is likely to achieve equilibrium over the next two years that will support higher long-term natural-gas prices.  Supply has increased substantially primarily due to reduced industrial demand during the recession and a warmer than usual winter in the north east U.S.  However, many natural-gas exploration and production companies have reduced their drilling plans for 2009, which will result in less gas going into storage over the next two years.  The supply-demand fundamentals are expected to improve considerably when industrial demand starts to pick up in light of reduced drilling.

The energy equivalency of natural-gas compared to oil is generally 6,000 cubic feet to one barrel of oil, and the price for 1,000 cubic feet (1 Mcf) will generally trade for one-sixth of the price for one barrel of oil during normal times.  As you are well aware, we are definitely experiencing anything but normal times in the current environment.

Over the past two years oil has traded for about 10 to 12 times the price of natural-gas.  With current prices for oil at about US$61 per barrel and natural-gas at about US$3.40 per Mcf, the ratio is almost 18 to 1.  Natural-gas prices stand to benefit from closing the gap in pricing relative to oil prices.

Natural-gas prices have spiked twice in the past four years and accompanied spikes in oil prices – in 2005 after hurricane Katrina hit Louisiana and during last year’s run-up in prices.  Another price spike could occur when the supply-demand outlook improves.

An opportunity to benefit from a recovery in natural-gas prices, particularly a price spike, is through the United States Natural Gas Fund (UNG: NYSE, $13.70), which invests in near-month natural-gas futures contracts.

In the chart below note the significant downtrend in the price of UNG over the past year.  The downtrend is still intact but the price is ripe for a breakout later this year, which could set the stage for a significant trend reversal.

UNG-NYSE Natural Gas ETF
UNG-NYSE Natural Gas ETF
UNG’s price experienced an exhaustion break in this downtrend, also referred to as a whipsaw, during May but was unable to find support at the downward trendline, probably due to last week’s natural-gas storage update.

Over the past few months UNG’s chart has formed a right-angled broadening formation, which is an accumulation pattern.  A buy-signal will be triggered if volume expands on a breakout above the top line in this formation, which is at about US$18.  A breakout will be confirmed if the price moves 10 per cent above this top line – to about US$20.

A subsequent pull-back towards the top line of the formation, which would become a new support level, would offer a low-risk entry point.  Although the gain from US$13.70 to US$18 is foregone, the US$18 entry level after a pull-back would reduce the risk of the investment considerably.  Also, breakouts from these consolidation patterns are generally followed by substantially price increases, so the potential increase from the US$18 level is enormous.

Inflation is pending in the U.S. with the government “printing” money to save its economy.  The U.S. dollar is expected to weaken relative to other currencies, including Canada’s petro-currency, and commodities – particularly oil and gold – are seen as hedges against inflation and a considerably weaker U.S. dollar.  As a result, investors need to consider that higher commodity prices in U.S. dollar terms will likely be impacted by a weaker U.S. dollar.

In any event, the outlook bodes well for natural-gas prices beyond 2009 and UNG provides investors an opportunity to benefit from a recovery in natural-gas prices.  The potential for the price discrepancy to close between gas and oil prices adds to the appeal of this investment opportunity.

Brian Hoffman, CA, CPA, is an affiliate of the Market Technicians Assoc. and a member of the Canadian Society of Technical Analysts (E-mail: bk.hoffman@rogers.com)

Tweeting at www.twitter.com/oilandgasinvest

By
Keith Schaefer
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Tweeting on Twitter.com

I had a Eureka! moment this week.  My marketing team and several web-savvy friends said I should be “tweeting”, or posting comments to www.twitter.com. I still don’t understand Twitter.com, but I did find a use for it which all readers should know about. 

When I’m doing my reading and research for stories, whether it’s about the industry in general or specific stocks, I come across lots of fun or unique facts that aren’t worth a full story.  Or even a full blog post.  So what I’m going to do is put them up on twitter.  You’re only allowed to write 140 characters, so I’ll have to keep it brief and relevant.

So I’m going to share some of my short musings at my twitter account – www.twitter.com/oilandgasinvest — more often now.  Interesting facts, links to articles with intriguing points of view, teasers of future articles…that’s where I’m going to post a lot of that.

Twitter even has its own lingo.  I am now what’s known as a stocktwit.  My wife could have told them that.

Portfolio Update

By
Keith Schaefer
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0

The first two purchases for the newsletter, Rock Energy (RE-TSX) and Petrobank Energy (PBG-TSX) each announced their first quarter (Q1) results in the last week.  Both met or exceeded expectations, as oil prices were better than expected through March.  Both companies simply continued doing what they have done the last year – find oil cheaply and extract it profitably.

Heavy oil prices in particular remained strong for Rock, making them one of the most profitable junior oil and gas companies, per barrel of oil, on the Toronto Stock Exchange. 

Heavy oil trades at a discount to the “light” oil price that is the one usually quoted in the media. But over the last several months that discount has been smaller than normal, as most of OPEC’s production cuts have been heavy oil – it costs more to produce, so in times of low oil prices it’s the first to go.  Simple economics say that when supply goes down, prices go up, and so has it been for Canadian heavy crude, as it has replaced Mexican and Venezuelan heavy crude taken off the market.

So as the oil price slowly moved up from $38 – $50 through Q1, heavy oil had an even greater percentage rise – as the discount went from 36% to 29% in Canada.  That may not sound like much, but it has turned a traditional lower profitability sector of the energy market into one of the most profitable right now.  And as Mexican production continues to decline, that differential could even get smaller.

Management at Rock got a better price and better production – President Allan Bey said their average 3818 barrels of oil per day (bopd) production beat their own estimates by 150 bopd.  Rock drills small wells – an average of only 40 bopd, but are very good operators.  They get a well producing for about $525,000, or just over $13,000 per flowing barrel.  Rock currently trades for about $21,000 per barrel.

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What’s a Frac – or WAF?

By
Keith Schaefer
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One of the two most important technologies in the development of the natural gas market in the last few years is “multi-stage fracing” (pronounced “fracking”), which is short for fracturing, as in fracturing the rock in which the oil and gas is held.  (The other technology is Liquid Natural Gas, or LNG).

Fracing is sending a specially designed fluid down the oil or gas well at high pressure and blowing it out into the reservoir rock to create cracks and channels through which the hydrocarbons can get to the well.

How big an impact has multi-stage fracing (MSF) had? Once the industry figured out how to frac the shale rock formations to get at all the natural gas they hold, it opened up huge new reservoirs across North America, and is the leading reason on the supply side as to why the price of natural gas has plummeted.

It’s exciting for the industry and investors because improvements to MSF are still being made – the industry is continually getting more production, more fracs, or stages, per well. Initial fracing was done in 4 stages over 500 meters.  Now you can see 16 stages over a 1600 metre horizontal length.  (One active fracing company said this week that the average Montney well has 7-12 fracs).

The industry hasn’t hit the end of what MSF can do; innovation is still happening.   And they’re fracing tighter and narrower reservoirs or payzones.  One of the largest oil discoveries in North America is the Bakken play, which straddles the Dakotas and  Saskatchewan (the US Geological Society estimates over billion barrels are there)  – but the zone can often be as narrow as 3 metres, or 9.5 feet.

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

By
Keith Schaefer
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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.

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New Stock Purchase; A Calgary Expert Says Low Natural Gas Prices are Here to Stay

By
Keith Schaefer
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Today I purchased 500 shares of Petrobank (PBG-TSX) at $24.10.  Please see my report on Petrobank under the Sample section of the website.

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Peter Tertzakian is a well respected oil and gas analyst in Calgary.  He has authored a couple books on oil and energy, and is chief energy economist at ARC Financial, a buy-side firm (institutional money manager).

His views on natural gas was the focus of a big story today in one of Canada’s two national business papers, The National Post.  Here is the link to the story:

http://www.financialpost.com/story.html?id=1513242

Natural Gas Prices Goes Down, Natural Gas Stocks Go Up

By
Keith Schaefer
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0

Natural Gas Prices are setting new lows almost every week – and everyone expects them to continue lower for some time.  But natural gas stocks are going up. 

Investors clearly believe that the collapse in the number of rigs searching for oil and gas is going to mean a sharp reduction in gas supply sometime in the coming months, causing gas prices to rebound.  Consensus from many analyst reports I have read suggest that won’t happen until Oct-Nov this year, but all are recommending to their investors to begin positioning themselves now.   

And the charts on the natural gas stocks say investors are listening.

Stocks do lead fundamentals by 6-9 months.  And the many reports that I read are telling investors that when natural gas prices turn up (due to either much lower gas injections into storage in the summer or much larger net withdrawals from storage starting in October) it will be a very fast move up.

It’s only April, but I can almost smell the pent up demand from the market waiting for that first really bullish gas inventory number.  And that’s what makes me think this gas market could stay lower for longer than most people think – but the rise in natural gas stocks says otherwise.

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Rock Energy and Why Heavy Oil Has a Light Discount

By
Keith Schaefer
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0

The heavy oil price in Canada has been surprisingly strong this year, and that led me to purchase some Rock Energy (RE-TSX) on Friday.  It is one of the few (I’ve only found 2) juniors with exposure to heavy oil.  The stock is cheap on several metrics compared to their peers – so cheap that if it was bought at the valuations some of these juniors are getting upon takeout, at least one brokerage firm estimates the stock could be a double or triple. 

Rock currently has a recycle ratio of 1.9:1 – meaning they get $1.90 in profit per barrel of oil (boe) for every dollar in costs they have in getting it out – and almost nobody in the industry, gas or oil, is generating 2:1 at these energy prices. Few investors associate heavy oil with high profitability, but President Allan Bey and his team are doing it. (Rock is 1.9x company wide; but it is half natural gas – brokerage firm National Bank estimates the recycle ratio on just Rock’s heavy oil is probably 3.4:1 – very strong.)

So it is highly profitable, and they have had a high success rate in their heavy oil play, called Plains Core, and 60 low risk drill locations in this Alberta play are ready to go. But the wells only average 40 bopd, and with regular decline rates of 30%, along with a regular debt load (75% of the limit) make Rock a no-growth story for 2009.

So why did I buy on Friday?

 Because I don’t think the new heavy oil story in Canada is out there in the market, and that presents an opportunity to investors who do their research.

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