The overhang of ready supply places a fairly firm cap on the price

NATURAL GAS
At the height of its late 2005 rally, natural gas in the U.S. was selling for just over $16/MMBtu, 350% higher than today’s price of $3.56. The oil/gas ratio, now over 18, is an all-time high… suggesting that natural gas is dirt cheap. So, it’s a buy, right?

In a phrase, not exactly.

According to a recent report by Natural Gas Intelligence, U.S. natural gas available for production “has jumped 58% in the past four years, driven by improved drilling techniques and the discovery of huge shale fields in Texas, Louisiana, Arkansas and Pennsylvania, according to a report issued Thursday by the nonprofit Potential Gas Committee (PGC).”

According to the report, the increase in gas discoveries and production improvements means that North America shouldn’t have to be concerned about gas supplies for up to 100 years!

Dr. Marc Bustin provided an overview of the situation in the May edition of Casey Energy Opportunities.

In the United States, the tremendous growth in natural gas resources and estimated recoverable natural gas, particularly from gas shales, just in the last two years (Figure 1) is sending tremors through the entire industry. These tremors include the risk of making obsolete the proposed $26 billion Alaskan and $16 billion northern Canadian pipelines to tap northern gas resources and a slue of proposed LNG terminals… unless they are for export!

The numbers currently kicked around are that something around 2,000 trillion cubic feet of gas are technically recoverable in the United States. At current production rates, this supply would last about 90 years.

Some analysts are predicting that even if the U.S. economy recovers in the next year, the amount of gas discovered to date in gas shales will severely dampen any increase in gas price for some time. According to a new study by energy consulting firm CERA (Cambridge Energy Research Associates), new technologies for unconventional gas fields are being applied so successfully that supply is essentially no longer a driver in either production or price in the North American gas market – whatever the market wants, North American gas fields can supply. CERA reports that natural gas production in the Lower 48 states has risen a startling 14% from 2007 to 2008, for example.

Figure 1. Major shale areas or formations in the U.S. and the estimated recoverable natural gas in 2006 and 2008. Modified from Daily Oil Bulletin (May 4, 2009).

Given the increase in production and the small slide in demand, the price of natural gas has fallen to around $3.50-$4.00 per MMBtu (down from $13 per MMBtu last summer). At these prices, many gas prospects are uneconomic, and thus there has been a marked decline in the number of wells being drilled. Rig activity (how many rigs are operating) is down about 50% in North America.

But here is where an interesting feedback mechanism kicks in. One of the characteristics of unconventional shale gas wells, and to a lesser extent natural gas wells in general, is that the production rate declines through time. Most shale wells’ production rates decline 60 to 90% in the first year. If you were a gas company trying to survive amidst today’s low prices, the rate of return on your capital investment would also be painfully low for a significant amount of gas if this were your initial year of production.

Another complementary fact is that over 50% of natural gas consumed in the United States today is from wells drilled less than three years ago, and 25-30% of the gas produced today comes from wells drilled last year (Figure 2).

Hence it follows that if there are 50% fewer wells drilled this year (from the drop in rig activity), new production will decline about 35-40% by the end of the year, so there will be gas shortages. Those will in turn lead to higher North American prices, which in turn should lead to additional drilling.

Figure 2. Historical gas production in the U.S. showing the percentage of production from vintage of well (modified from Chesapeake April 2009 Investor presentation from original data of HIS Energy)

Everything else being equal (which it’s not, this being the real, not the mathematical world), gas prices and drilling will see-saw until an equilibrium is reached. In detail, of course, things are more complicated, but it is pretty clear that gas prices will have to rise within the year, and the big losers will remain the more expensive plays that require higher gas prices to be economic.

Where will the gas price end up in the short term? A poll of analysts by Reuters suggests $6 MMBtu in 2010 (Daily Oil Bulletin, May 4, 2009), but I don’t think I would bet on a gas price based on a vote by analysts. At the same time, it’s an interesting coincidence (or not – coincidence, that is) that many prospects become economic at around the $6 MMBtu range. Among them are the Haynesville and Marcellus shales – and it’s no large leap from there to see their tremendous gas production potential acting as a buffer to gas prices going much higher in the near term.

Thus, while there may be some seasonal and relatively short-term trading opportunities in natural gas, the overhang of ready supply places a fairly firm cap on the price. Which begs the question, which big-trend energy opportunities should be getting our attention today?

Marin Katusa, who heads the Casey Research energy team, answers the question by, correctly, cataloging the opportunities according to geography.

In North America
1. Geothermal — the most interesting of the alternative energy sources, by a wide margin.

2. Nuclear.
3. Oil.

In Europe

1. Unconventional gas has, by far, the most upside.
2. Unconventional oil.
3. Small hydro (such as run of river).

In Africa

First and foremost, you want to avoid infrastructure plays (pipelines, refineries, etc). Then you want to look for areas with huge oil potential, which have been held off the market by concerns over political risk. I like what Lukas Lundin is doing in Ethiopia, Somalia, and Kenya, hunting for “elephants” with the idea of eventually selling the discoveries off to the Chinese.

In Asia,
1. Liquid Natural Gas (LNG)
2. Coal Bed Methane (CBM)

Lessons to learn

There are a couple of useful lessons to be derived by investors looking to tap into the virtually unlimited opportunities in energy.

First, just because something is “cheap” doesn’t mean it can’t stay cheap, regardless of historical ratios — if there has been a fundamental shift in the supply/demand equation. Which is very much the case with North American natural gas.

Secondly, geological and transport considerations make much of the energy complex a “local” market.

For example, while North America enjoys an abundance of natural gas, Europe is forced to rely on the heavy-handed Russians for the bulk of supplies. As you read this, there are companies looking to break the Russian grip by applying the same unconventional gas technologies that have so successfully built gas supplies in the U.S. — technologies that are only just now being applied in Europe. Early investors could reap huge profits.

In short, the real opportunities are not found by simply “investing in energy” but rather by taking the time to understand the structural differences within the energy complex and cherry picking the special situations that invariably exist in a sector this large.

Natural Gas ETF Plunges More Than Fuel Even as Shares Sell Out

The largest exchange-traded fund for natural gas, so popular that it ran out of shares two weeks ago, it has lost 43 percent this year and probably will keep falling until winter, trailing the fuel it’s supposed to track.

The United States Natural Gas Fund will suffer from record- high gas inventories and seasonal prices hitting the ETF harder than the fuel, said Teri Viswanath, the director of commodities research at Credit Suisse Securities USA in Houston. Investors piled into the fund this year, driving up its number of outstanding shares 11-fold.

“The amount of interest in this fund is a surprise given the trend in gas is down and not looking to change any time soon,” said Tom Orr, the director of research for Weeden & Co. LP, a Greenwich, Connecticut, securities brokerage, in a telephone interview. He predicted natural gas, this year’s worst performing major commodity, will fall below $3 per million British thermal units next month, from $3.669 on July 17, and rise to $4 in the fourth quarter.

The $4.6 billion fund, managed by United States Commodity Fund LLC in Alameda, California, made 300 million new shares available May 6 and grew to 347.4 million shares before running out July 7. It’s awaiting Securities and Exchange Commission approval to sell up to a billion more.

“If I knew then what I know now, we certainly would have registered a lot more shares than 300 million back a few months ago,” said John Hyland, the ETF’s chief investment officer.

Commodity ETF Boom

Its popularity coincides with a boom in commodity-backed funds. Investors poured $16.9 billion into such ETFs this year through May 31, more than triple last year’s first five months, according to the Investment Company Institute, a Washington trade group.

The Commodity Futures Trading Commission, in an effort to prevent speculators from pushing around energy prices, will hold hearings this month on limiting how many oil and gas futures that speculators, including ETFs, can hold. The Industrial Energy Consumers of America wants the SEC to block the fund’s expansion to prevent “excessive speculation,” according to a July 16 letter from the trade group, which includes Goodyear Tire & Rubber Co. in Akron, Ohio, and Tyson Foods Inc. in Springdale, Arkansas.

Investors bought the natural gas fund expecting the fuel to rise after it fell in June to the cheapest level compared with oil since 1992, Orr said. Instead, gas continued a yearlong slide. Since Dec. 31, natural gas futures on the New York Mercantile Exchange have declined 35 percent, 8 percentage points less than the ETF’s drop.

High Supplies

Fuel stockpiles increased 90 billion cubic feet the week ended July 10, reaching 2.886 trillion cubic feet, the highest for any July since the Energy Department started keeping records 15 years ago. Consumption by factories, steel mills and chemical plants, which accounts for 29 percent of U.S. demand, tumbled 13 percent in 2009’s first four months compared with 2008, the most recent Energy Department data show.

Viswanath predicts supplies will reach an all-time high by late October, making price increases unlikely until the first quarter of 2010, when cold weather and the early stages of an economic recovery boost demand.

The fund aims to mimic price changes in futures contracts on natural gas delivered to Henry Hub in Erath, Louisiana. It buys contracts for delivery in the next, or front, month. As those contracts near expiration, the fund sells and replaces them with the following month’s futures, a process called rolling.

Contango

Rolling hurts performance when the current contract is worth less than the next month, known as contango. The natural gas market has been in contango 94 percent of the time since the fund started in April 2007, compared with 78 percent since April 1990.

Contango doesn’t matter as much when prices rise. Gas cost $7.50 when the fund debuted and increased 81 percent to a 2 1/2- year peak of $13.58 on July 3, 2008. The fund gained 25 percent during that time, besting the Standard & Poor’s 500 Index, which fell 14 percent.

The ETF gave retail investors a way to “tag along on the commodity plays,” said Orr, who sometimes trades the fund in his personal account. When the fund started, “contango was not a factor, since people saw gas in a bull trend.”

From last year’s peak to now, gas has fallen 73 percent, and the S&P 500 has lost 26 percent. The gas ETF is down 79 percent.

‘Double Whammy’

For the fund’s investors, “even if prices stay stagnant, they lose on the roll,” Viswanath said. “If prices fall, it’s a double whammy.”

The steeper the contango, the more expensive rolling becomes. Contango has started increasing in late August and remained elevated for up to about three months every year for the past decade, data compiled by Bloomberg show. On Aug. 28, 2008, the spread between the front and second months doubled to 42 cents. On Aug. 30, 2007, it surged six-fold to 97 cents.

August is when traders move out of bearish bets made during the U.S. summer to wager that Gulf of Mexico hurricanes or cold snaps will increase prices as winter approaches, said Chris Jarvis, president of Caprock Risk Management LLC in Hampton Falls, New Hampshire.

Hyland, the fund’s chief investment officer, said contango is just one issue to consider when investing. The ETF offers a way to diversify, to bet on energy and to hedge against inflation, he said.

Profiting ‘Easily’

“The fund was designed for the majority of investors, both professional and retail, who can’t or don’t want to invest directly in futures,” Hyland said in a July 14 telephone interview. “If you believe that natural gas is cheap and that it’s going to rally and move back to the $7 or $8 range, then even if it stayed in contango the whole time, you could easily come up with a scenario where you make money.”

Jarvis said investors can profit on the ETF and avoid contango’s bite with options to buy shares in January and February at prices set now. Buyers would profit if the fund gains more than the sum of that so-called strike price and the option’s cost.

He predicted gas prices as high as $5.20 by then because producers will struggle to meet increased demand as the economy recovers. The number of active U.S. rigs has fallen to a seven- year low of 665 from a peak of 1,606 on Sept. 12, according to Baker Hughes Inc., an energy services company.

“The value on the curve isn’t in the front month,” Jarvis said. “It’s in the January and February contracts.”

Natural Gas Declines on Speculation Inventories Will Increase

Natural gas fell for a seventh day in New York, the longest losing streak in two years, as a government report tomorrow may show that slack industrial demand amid the recession is adding to a supply glut.

July 8 (Bloomberg) — Gas inventories probably increased 85 billion cubic feet last week, based on the median of 15 analyst estimates compiled by Bloomberg. Storage levels rose to 2.721 trillion cubic feet in the week ended June 26, 21 percent above the five-year average, the Energy Department said on July 2.

“We’re going to be at record storage or near it,” said Chris Jarvis, president of Caprock Risk Management LLC in Hampton Falls, New Hampshire. “The lack of demand and big storage builds” are weighing on prices.

Natural gas for August delivery declined 7.6 cents, or 2.2 percent, to settle at $3.353 per million British thermal units at 2:58 p.m. on the New York Mercantile Exchange, the lowest since April 28. Futures have dropped 15 percent since June 26, the last day the fuel advanced.

“Prices are bound to fall to $3 by the end of October, and I’m afraid that may be too high with no major events this summer, no hurricanes that would disrupt production or pipeline maintenance,” said Laurent Key, an analyst at Societe Generale SA in New York.

Industrial consumption is forecast to drop 8.2 percent this year and total demand will slide 2.3 percent to 62.1 billion cubic feet a day, the Energy Department said yesterday in its monthly Short-Term Energy Outlook.

Consumption of gas at factories, steel mills and chemical makers, which accounts for 29 percent of U.S. demand, has tumbled during the slowdown. Power generation is also about 29 percent of gas usage.

Bearish Weight

“Fundamentals have been bearish for a long time on this market,” Key said. “We’ve had a huge storage injection pace due to really high production in the U.S., despite low prices.”

Producers have slashed output. The number of gas rigs working in the U.S. last week totaled 688, down 57 percent from 1,606 in September, according to Baker Hughes Inc. data.

U.S. natural gas production will fall 0.6 percent to 58.23 billion cubic feet a day this year from 2008, the Energy Department said yesterday.

Mild weather in large population areas has stifled consumption by power plants to meet air conditioner demand, and there have been no storms to threaten output, Jarvis said.

No Hot Weather

Average and below-normal temperatures are forecast through July 21 in an area stretching from North Dakota to New York, according to the Climate Prediction Center in Camp Springs, Maryland.

“We haven’t had the hot weather to jack up demand” and whittle supply, Jarvis said.

The hurricane season began June 1 and runs through November, producing storms that have the potential to enter the Gulf of Mexico and disrupt production from offshore gas platforms.

Natural gas also slid as crude oil futures plunged a sixth day in New York after an Energy Department report showed the sour global economy has crimped consumption. Total U.S. daily fuel demand averaged 18.4 million barrels in the past four weeks, down 5.9 percent from a year earlier.

“Gas prices continue their descent, gathering directional momentum from the rest of the complex and the deteriorating technical picture,” Michael Fitzpatrick, vice president for energy at MF Global Ltd. in New York, said in a report.

To contact the reporter on this story: Mario Parker in Chicago atmparker22@bloomberg.net.

Oil Price to Match Record $147 in Three Years, Pickens Says

July 7 (Bloomberg) – T. Boone Pickens, founder and chairman of Dallas-based BP Capital LLC, said oil prices will match last year’s record $147 a barrel in three years as producers fail to increase output.

“We’ll be flat at 85 million barrels a year,” Pickens said in an interview. “By 2013 we’re going to see a decline in production. In 10 years we’ll be at $300 a barrel.”

Pickens, 81, one year ago started a $60 million promotion for a national energy plan that relies on domestically produced natural gas to cut U.S. dependence on foreign oil. Without a switch to gas, the U.S. will be spending $2 trillion a year importing oil, he said.

“The problem is we don’t have the oil,” Pickens said. “And we’ve got gas coming out our ears.”

Crude oil futures for August delivery today fell $1.12, or 1.7 percent, to $62.93 a barrel on the New York Mercantile Exchange. The price has gained 41 percent this year.

Oil is not going to get any less expensive relative to natural gas, Pickens said. He said gas needs no refining and emits 50 percent less pollution than gasoline.

His plan has received some support in Congress, said Graham Mattison, an analyst at Lazard Capital Markets in New York.

“Political support for the natural gas vehicle industry continues to build,” Mattison said. A House bill would double some natural-gas vehicle tax credits and double the amount stations would get to install pumps for the fuel, he said. The Senate may consider similar legislation tomorrow, he said.

Gas Market to ‘Tighten’ on Demand, Bernstein Says

July 2 (Bloomberg) — U.S. natural-gas demand from industry and increased power generation will cause the gas market to “tighten” and push up prices, Sanford C. Bernstein & Co. said.

The market will “tighten considerably toward the end of the year,” while delays in starting liquefied natural gas projects will also bolster prices, Neil McMahon, a London-based analyst at Bernstein, said today in a report.

New York gas futures have fallen 33 percent this year as the recession forces factories to shut and cuts power demand. BG Group Plc, the largest supplier of LNG to the U.S. in 2007, in June said there’s a global gas surplus. Lower costs may spur use by power generators and boost prices as LNG proves unable to offset a drop in U.S. onshore gas output, Bernstein said.

“Some LNG plants are having a gentler startup than they would have done” because of lower demand, BP Plc’s Chief Executive Officer Tony Hayward said June 10. BP is set to load its first LNG cargo from Indonesia’s Tangguh gas plant later this year. LNG is natural gas chilled to a liquid for transportation by ship.

Qatar, Russia

Two new LNG production units, in Qatar and Russia, have started this year and five are expected to start before the end of the year, Bernstein said. LNG production capacity was forecast to increase 27 percent in 2009.

“We do expect significant new supply to hit the market this year, but its impact should be staggered, and more weighted towards the end of the year,” Bernstein said.

Europe and South America may import more this year as demand rises, stockpiles dwindle and LNG import terminals start, taking fuel that may have gone to the U.S., Bernstein said.

The U.S. will import about 1.5 billion cubic feet a day of gas this year in the form of LNG while the number of gas drilling rigs will decline by 57 percent, Bernstein said. The import rate “ramps up” in the fourth quarter.

“A large wave of LNG imports into the U.S. is unlikely before the very end of the year,” Bernstein analysts McMahon and Ben Dell wrote. “Despite an estimated year-on-year increase of 50 percent, this should not be enough to oversupply the domestic market.”

Imports to Asia “should be more resilient than expected due to rigid contracts in Japan and South Korea, and growing imports into China and India,” Bernstein said.

Strategy Update

2 July 2009-
“Short everything and remain short ! except for the DOGS !!”
levels at present, Dow 8280, Gold 929.30, Oil 66.20, USD Index 79.66, EURUSD 1.3998, Copper $2.2689, Nickel $7.4382, *DOG 67.81 *this one is a short play and should go up as the DOW falls… double short DOW

TECHNICAL STUDIES & OUTLOOK
DOW JONES     downtrend
confirms breakdown in uptrend… support around 8220 levels, look for that level to be tested and likely broken if downtrend moves in earnest.
Fundamentally there are a lot of negative issues recently that could materialise:
- California default, Recent stock issuance globally to cap rises and provide downside liquidity, unemployment high, Eastern EU countries that could default on their bonds leading to Western EU states facing more write downs, lack of consumer spend and travel to hit hotels and commercial prop portfolios, Record Bond issuance leading to higher and higher bond rates (bad for stocks)
- Good news ? we have summer… oh that means less market participation and winter months for miners = less mining in winter
- $INDU for chart on www.stockcharts.com

OIL & Coal     downtrend
broke down into down trend a few days ago and todays decisive $2.00+ drop to $66 range confirms the down trend move is underway…this could logically lead to the capitulation of the metals rally also. Interesting to note that the Dow Jones Oil and Gas Index has also broken down. Stay short commodities with Oil leading the way lower !
Expect coal stocks to also suffer from the breakdown in oil… note that the coal prices for delivery in all 3 major areas have had 2 down weeks following recent up moves… is that a sign that the coal prices have resumed a downward move.
- $WTIC

GOLD     downtrend
Stuck under $940… failed to break through it after a few attempts this week. *more details under GOLD in index page. $GOLD

METALS     uptrend, but becareful
still in uptrends but with oil breaking down… becareful

USD Index     downtrend
still in downtrend
interestingly EUR might be having more issues soon versus the USD… EURUSD used to top out at $1.40 or so… but seems like the EUR might strenghten pass that point at present. Let’s see if it manages to break up decisively.
There was a comment from a fund manager that the recent CNY strenght against the USD was the cause of all the extra funds coming into the oil complex.
- $USD

BONDS, INFLATION and ECONOMIES               30yr yields downtrend
30year US Bond yields topped out at 5% recently and seems to have broken down… with it entering a downtrend at present. Looks like funds are shifting back into Bonds at present and yields might continue to fall for now. This would be contrary to the inflation fears that has been in the forefront recently, with metals prices and oil spiking up strongly.

Contrary Fundamental Backdrop (on hold for now)- Govt issuance of bonds to continue as funding needed for massive deficit spending at present… expect bond prices to keep dropping and rates to keep moving higher on the long end, even though for now the govts are artificially pressing the short end rate yields down…it could be possible that funds are coming back into bonds with more instability to come and economic meltdown to persists.
-  ECB rate confirmed to remain at 1%, unemployment 9.5%
-  USA unemployment 9.5%
-  Australia to continue to maintain its rate without hiking as trade deficit doubled ! in recent report… exports dropped significantly with the global slowdown
-  10 year Note yield $TNX, 10yr 3x Bull and Bear TYD, TXO, or 2.5x Bull Bear Fund DXKLX, DXKSX…
     or TBT ProShares Ultra Short 20+ Year Treasuries (price of bonds down these things   move up)
-  30 year US Bond Yield and Price- $TYX and $USB within www.stockcharts.com or yields can be found at  http://www.bloomberg.com/markets/rates/index.html

CHAIN OF EVENTS
nothing new comes to mind at present
*note- the recent stock issuance statistically points to 10-15% decline in the markets in the following months

Previous Chain of Event effect- 
…….

INVESTMENT THEMES
based on investment ideals (buying when prices are very cheap – trading at very low prices, most likely driven by the current fear or very bad present outlook,… but only buying where the “value” that one buys would hold or grow. Then waiting for prices to move higher when the situation or perspective normalizes)
1. Natural Gas… trading at 18x ratio to oil… as opposed to the historical 6x or so… Gas is not getting the speculative funds pushing it up and at present suffers from the perception that with weakening economies there is less need for power and therefore gas. It is used in a large percentage of industrial power production. At under $4.00 it is priced under the marginal costs of production and no one will be selling more for less than they can produce it… though there is no news that will support the price at the moment, it is trading at historical lows and at a large discount to oil prices… buy at the worse points when things are looking their worse and prices are at record all time lows and wait for things to turn around.*search for Natural Gas within this blog for more info on NatGas.
2. NZDAUD trading at under 80c… it ranges from 1 NZD buying 95c AUD to recent lows 1 NZD buying only 78c AUD… longer term historical range (15 years) shows 75-95c ran

RISK: Major issues to watch out for
1. Eastern EU states like Latvia, Hungary or something similar to default leading to a Western EU state to crash… ie Sweden who has loaned billions to these Eastern States.
2. GBP or other major currency crisis – Jim Rogers has forewarned this as a possibility within the next 6 months

Natural Gas Futures Moving Toward $5: Technical Analysis

Natural gas futures are heading toward $5 per million British thermal units as price support builds for the power-plant and industrial fuel, according to a technical analysis by Chris Jarvis, president of Caprock Risk Management LLC.

The futures contract has rallied and retreated three times since dropping to $3.155 per million Btu on April 27, the lowest in more than six years. Gas now has established a support line that may push prices into a range of $5 to $5.20, Jarvis said in a telephone interview.

“Natural gas could be coiling for a move higher,” said Jarvis, who is based in Hampton Falls, New Hampshire, and is a chartered market technician. “The $3.60-to-$3.80 area has been a big area of support and we’re holding that again. The longer we stay down here, to me, the bigger the upside move.”

Jarvis said gas will have to break through an area of resistance at $4.38 and then $4.575, the latter of which was a three-month high reached on May 13, before reaching his target price this summer.

Natural gas for July delivery rose 10.5 cents, or 2.7 percent, to $3.949 per million Btu on June 26, its last day of trading on the New York Mercantile Exchange. Prices are down 71 percent since reaching a 2008 high of $13.694 per million Btu on July 2.

Moving averages, an indicator watched by some technical traders, also appear set to turn higher, another bullish signal for natural gas, Jarvis said. Gas last week closed above the 50- day average, which has reached about $3.84 per million Btu.

“The 50-day moving average is starting to turn up and the 100-day is starting to make that same move,” he said.

Technical traders monitor patterns on daily charts for clues to price direction, and may sell or buy based on those signals. The moving average shows the average value of a security or commodity over time.

Natural Gas investment idea

Natural gas, in particular, is a resource the U.S. has in ample supply – 35% more than previously estimated according to the most recent survey by the non-profit Potential Gas Committee. In natural gas, at least, supply is outstripping even rising demand.

Natural gas prices exceeded $10 per million BTUs in 2002 and topped $15 in 2005 vs. current levels around $3.90. “The dramatic run-up in the earlier part of the decade spawned a lot of advancements in technology to extract gas once thought unrecoverable,”