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Expect Natural Gas to Trade Even Lower


A simple pair trade would be to short an E&P company with large exposure to dry gas and go long a company with large exposure to wet.

MINAYNVILLE ORIGINAL Many people are getting "bulled up" on natural gas based primarily on its seemingly low price. I have some tough news for bulls: Natural gas is likely headed lower (maybe much lower) as there are no real catalysts to drive the price higher and incentives for E&P (exploration and production) companies to keep producing.

There are a couple of things to consider starting with wet gas versus dry gas. Dry gas producers have already started to erode because they are drilling solely for gas, and at these prices, they are starting to lose tons of money. Many of these same companies are also forced to keep drilling or they will lose their land leases; Chesapeake Energy (CHK) is an example. Meanwhile, wet gas producers can and will keep pulling gas out of the ground as long as oil is at these levels. Frankly, as long as it's over $80 per barrel I believe it's quite unlikely to see any slowdown in production from these players. That means that even at $1, gas will keep coming from these wet plays because to them it's free money. Knowing that, it's not inconceivable that we could see sub $1.50. Think about that for a minute. That's almost 30% down from current prices.

One thing that could cause a temporary pop would be an incredibly hot summer – especially in the Northeast and Midwest (areas that usually maintain a more moderate temperature). This would be a shortable opportunity in my opinion.

Regarding utilities shifting to gas from coal or the exporting of gas, we are two to three years away on each before supply starts to draw down. At current production rates, stockpiles will build to a point that means we may be as many as four or even five years away from seeing gas prices start to rise meaningfully. Until then I think a lot of "long term longs" will tie up capital in an unproductive asset.

So how do you trade this?

Some potential plays in this area are pipeline / storage MLPs (master limited partnerships) like Plains All-American Pipeline (PAA) which also has public subsidiary PAA Gas Storage (PNG) or Enterprise Products Partners (EPD) which has a big exposure to NGLs (natural gas liquids) as well as midstream services including gathering, treating, processing, transport, and storage of natural gas and service companies like Heckmann Corp (HEK) which provides water delivery / disposal, trucking, fluids handling, treatment, temporary and permanent pipeline facilities, and water infrastructure services for E&P companies.

A simple pair trade would be to short an E&P company with large exposure to dry gas and go long a company with large exposure to wet gas against it. I'll make you do the research on which companies to pick!

Twitter: @axiosadvisors
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Positions in HEK, PAA

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