Friday, April 24, 2009

Natural Gas

If there is one thing to learn about commodities, it is a phrase one hears often in energy trading. The answer to high prices is high prices. A cyclical industry, commodities are driven by supply and demand with greater speed and clarity than economic products higher up the food chain.

In our geographic area of southwestern Pennsylvania, last year there was group hysteria as every property owner I know was scurrying to confirm they owned the gas rights beneath their feet. Drilling lease rates went from little more than single digits per acre to thousands of dollars over the course of several years. It was marcellus shale fever! You could almost see their lips moving as they figured, "200 acres times $3000 equals...whoa. A really nice new pickup truck!" And that didn't even consider the gas price over $10/mcf, 20% royalty rates and well over a million cubic feet per day production on wells.

Combine a slowing economy with a massive new production supply and Adam Smith's invisible hand of capitalism comes into view. Today the price of natural gas is below $4/mcf and lease rates back to earth. Back to old pick-up, smaller crowds at meetings and life in the slow lane once more.

But for investors, the answer to low prices is low prices. The Natural gas prices show no sign yet of returning to last years lofty levels but the decreasing rig count is the seed of the next cycle. Investors may want to consider taking exploratory small positions in natural gas if they have a time horizon of beyond the next weeks or months. Looking at the ETF chart for natural gas tells the story.

A decline (collapse) of more than 80% in less than a year to levels below production costs in some cases begins to look interesting for the patient. As the graphic below shows trees don't grow to heaven, but they resprout in time.

John Barnyak