It is November and we have had excellent warm weather so far. House heating is usually on the rise this time of year, but it doesn’t seem to be happening. Why is that?
It is called the El Niño effect. A warm winter and low natural gas prices translates to likely lower heating costs this year. All that is good news. Unless you happen to work for a natural gas producer or hold their shares, or have invested in natural gas as a commodity. Natural gas prices are nearly 50% down from where they were last winter. In fact, January futures hit 16 year lows as we head into the winter.
That has been the story of a lot of commodities this year. If you were tracking S&P GSCI for the last year, you would have lost more than 55% of the invested amount by now. This is definitely not business as usual. And that is exactly what a lot of shrewd investors look for in investment opportunities. The obvious question to ask is: have natural gas prices bottomed out? And is this the right time to buy?
Why The Worst May Not be Over Yet
It is always useful to argue your investment decisions from both sides before moving forward. Let us see why it might make sense to stay away from going long on natural gas:
- International Energy Agency (IEA) projects a lower global gas demand for the 2014-2020 period as compared to the previous ten years. Many countries in EU saw a moderate to high decrease in gas demand in the past few years. Part of this has to do with change in habits.
- China’s gas demand growth slowed down to single digits in 2014, a substantial slowdown from the 14% averaged growth during the prior five years.
- Coupled with lower demand is the issue of ever increasing supply. Innovation in finding natural gas, game changing technology of storage, has resulted in an almost excessive supply phase. Shale revolution, which barely started 15 years back, has now faded away. International Gas Union projects 40% increased capacity by 2020 (most of it coming from US and Australia).
This means the pressure on natural gas is not just from the demand side but also the supply side. The Asian slowdown in the last five years, it seems, has caught everyone by surprise. Clearly the supply graph didn’t match up with the demand graph.
Why it Might be a Good Time to Buy
Gas Co-Leader for Ernst & Young LLP, said earlier this year: “Looking forward to 2015 end-of-year reporting, we expect more impairments, with significantly reduced capital expenditures, revenues and year-end reserves, if the current commodity prices continue through the end of the year.” U.S. Energy Information Administration (EIA) published its weekly update on natural gas at the end of October. The report showed that US natural gas inventories in storage increased by 63 billion cubic feet (BCF), causing inventories to rise to 3,877 BCF that week. This was less than analysts’ expectations of a 69 BCF increase, resulting in a positive impact on gas prices and futures.
Lower commodity prices encourages new development projects. Lower raw material costs will eventually pull investments toward construction. Lower natural gas prices might just kickstart a bull phase led by Asia. Yesterday, Federal Reserve Chair Janet Yellen pointed to a possible rate increase in December. This topic of potential rate increase has not gone away in the last six months, despite the stock market correction. Clearly they don’t see anything fundamentally wrong with the world economy. If that is the case, the low growth rates and low commodity prices can’t last forever.
Other forms of fuel are giving way to natural gas. For example: according to the EIA, coal powered electricity production is on the decline due to the MATS regulations, and most of new capacity is going to come from natural gas, wind, and solar power (natural gas accounting for more than 30%). The same thing (although to a lower extent) is happening with petrol/diesel vehicles shifting towards CNG, especially in pollution-heavy developing countries like India and China.
The Bottom Line
It is very difficult to time the market; most investing gurus would advise against even trying to do so – it is much more fruitful to spot broad trends and act accordingly. For example, if the consensus is that the natural gas prices might fall a little bit more before it starts to make its way up, it is better to take a long position and wait. Instead of picking stocks, it is better to invest in indexes, and what better way to do it than ETFs? They take the complexity out of your hands and leave you with lower fees and tax obligations. Some interesting long natural gas ETFs are (UNG ), (UNL ), (UGAZ ) (3x leveraged ETF).
If, however, you feel the warm winter will put further pressure on prices and you want to make use of this opportunity, you could look at some inverse ETFs. With inverse ETFs you can take short positions in broad sectors without even shorting a single stock or constructing any complex derivative strategies. (DGAZ ) is a 3x inverse ETF that tracks natural gas futures. Another option is (KOLD ), a 2x inverse ETF.
Note about leveraged ETFs: leveraged ETFs are short term investment tools only. Long term leveraged ETF positions might see a decline in value, even if you were right about the overall market trend. Click here to read more on leveraged ETFs.