Natural gas seen as too cheap to ignore

On paper, the case for investing in natural gas is straightforward: It is a clean, largely domestic fuel now selling at 74% below its peak price of a year ago.
JUL 19, 2009
On paper, the case for investing in natural gas is straightforward: It is a clean, largely domestic fuel now selling at 74% below its peak price of a year ago. Despite the fact that natural gas is the worst-performing commodity year-to-date, a flood of money has poured into pure-play funds that offer exposure to it. Supply-and-demand fundamentals, however, have financial advisers, money managers and analysts wondering about the best way to approach an allocation to the commodity. Gas now sells at less than $3.50 per million BTUs, down from a peak of $13.50 last summer. Discounting the expected lower consumption and demand during the summer, gas prices are at about half their historical average and viewed by some as too cheap to ignore. That perspective has helped the United States Natural Gas Fund LP (UNG), an exchange traded commodities pool that tracks natural gas through futures contracts. Although its share price has fallen in tandem with the commodity, the fund can't keep up with investor demand (see related story on Page 19). Of the 480 million shares of the fund registered since its April 2007 launch, 300 million were registered in May. On July 5, the fund registered with the Securities and Exchange Commission to issue an additional 1 billion shares. “We thought 300 million shares was more than enough to take us through another year,” said John Hyland, chief investment officer at United States Commodity Funds LLC, a firm with $6 billion under management.in Alameda, Calif., “We certainly did not anticipate this kind of interest,” he said. “But we also had not anticipated that -natural gas would be trading in the $3 range.”
Despite many arguments being made for an allocation to natural gas, advisers and investors must recognize that the price has been going almost straight down for the past year, according to Tom Samuelson, chief investment officer at Advanced Equities Asset Management, a Phoenix-based investment and brokerage firm that manages more than $500 million. However, “part of the thematic bull case for natural gas is that it's cleaner than coal and is seen by some as a bridge fuel toward wind and solar energy,” he said. In addition to growing political pressure to move the country toward cleaner energy, the numbers continue to stack up in favor of natural gas, according to some analysts. For example, even as crude-oil prices fell 11% this year, through June, the 49% drop in natural gas over the same period expanded the price ratio between the two commodities from a historical average of 7-to-1 to 17.5-to-1. “Natural gas has gotten so far out of whack with the crude-oil ratio that it has the makings of a mean reversion trade,” said Joe Tatusko, chief investment officer of Westport (Conn.) Resources Management Inc., which manages $700 million, mostly in separate accounts. “Maybe it has overshot the mark on the downside, and natural gas might make sense for people with a six- to 12-month time horizon,” he added. “If one thought the economy was getting back on its feet, you could see a real whipsaw [natural-gas rebound] by the end of the year.” The threat of inflation is also driving investors toward natural gas, according to Tom Lydon, president of Global Trends Investments in Newport Beach, Calif. “It doesn't surprise me that the smart money might be buying natural gas at lower prices,” he said. “If inflation kicks in, we're going to see higher commodity prices in the next 12 to 24 months.”

BETTING ON A BAD WINTER

But even with the threat of inflation and bets on a brutal winter season, the reality of supply and demand cannot be denied. According to last week's report from the Energy Department's Energy Information Administration, the current stockpile of 2.9 trillion cubic feet of natural gas is 19% above the five-year average and 26% above last summer's storage level. According to Mr. Samuelson of Advanced Equities Asset Management, if the stockpile stays below 3.4 trillion cubic feet going into the winter months, it is considered a bullish environment for natural gas, but beyond 3.6 trillion cubic feet is considered bearish. “We'll get to winter with a very high inventory,” he said. “I think we'll get to 3.8 or 3.9 trillion cubic feet.” Unlike crude oil, which can be easily shipped around the world, natural gas is more of a regional commodity and for that reason tends to be consumed more rapidly once demand kicks in. This is why some investors are not overly concerned about the stockpiles. “I'm a firm believer in supply-side economics, and when something is beaten up and nobody likes it, that's the time to buy it,” said Mickey Cargile, managing partner at WNB Private Client Services LLP, a Midland, Texas-based advisory firm with $700 million under management. He described the appetite for natural-gas investments as a “vote of confidence that people believe the economy is turning the corner.” With natural-gas futures contracts for next year trading in the $6 range, some money managers are hedging the commodity with direct investments in drilling companies. “There will be continued pressure on natural-gas prices, but we're looking out three to five years,” said Chris Armbruster, a senior research analyst with Al Frank Asset Management Inc., a Laguna Beach, Calif.-based firm with $350 million under management. Two of his favorite drilling companies are Chesapeake Energy Corp. (CHK) and Apache Corp. (APA). E-mail Jeff Benjamin at [email protected].

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