Analyst fired up about natural gas

Veteran trader says price could reach $7 range by winter

By Gary Lamphier, Edmonton Journal August 21, 2011

It's been a long time since I bumped into anyone who is even remotely bullish on natural gas, the energy sector's unloved stepchild.

Roughly two years after the recession ended, natural gas prices remain stuck in the basement, as a tidal wave of new shale gas supplies gluts the U.S., Alberta's only existing export market.

Result: at the current price of less than $4 US per million British thermal units (MMBtu) in New York, natural gas is roughly 70 per cent below its 2008 high. Likewise, Alberta (AECO) spot prices are mired in the $3.65 range.

Contrast those ugly numbers with U.S. light crude prices - which hit a postrecession peak of $114 US per barrel in April, more than triple the lows of early 2009 - and it's easy to see why investors continue to prefer oil stocks, despite the recent correction in crude.

So when an unabashedly upbeat report on natural gas by Calgary money manager Josef Schachter landed in my inbox a few days ago, I was intrigued.

Turns out Schachter - a veteran trader who advises clients at Toronto's Maison Placements on energy issues - makes a compelling case that the bear market in natural gas is coming to an end.

In his view, natural gas prices actually bottomed last fall, and could rebound to the $7 range on the New York Mercantile Exchange by winter, as supplydemand forces come into better balance.

"People focus on production, and the production numbers are a mix of the conventional basin and shale, and shale (supplies) are still rising, as we all know," he says.

"But as these shale plays reach maturity - like the Barnett (in Texas) and the Haynesville (in Louisiana) - the amount of new production that's coming on (is offset by) what's starting to come off. So if you aren't on a treadmill drilling new wells, you're going to hit a peak."

With conventional natural gas output already falling sharply in Wyoming and the Gulf of Mexico, and total well counts down slightly in the Haynesville, that should help to put a floor under prices, Schachter believes.

Meanwhile, U.S. natural gas inventories have fallen below the five-year average while demand continues to rise, as cleaner-burning natural gas steadily displaces coal as a source for electric power generation.

"So you have less inventory, you have a potential production slowdown coming (as shale gas drilling plateaus) and you have demand rising, as shown by the inventory-to-sales ratio," he says.

Tack on the possibility that gas production in the Gulf could be curtailed this fall as hurricane season gears up, and you have the makings of a more bullish picture for natural gas, Schachter contends.

"But the stronger issue we're arguing is when you get into the winter of 2011-2012, if we don't have high inventories and we go into a normal winter, we'll see prices move back up to $7 on NYMEX and over $5 (Cdn) for AECO. That would be a big change and it would help Western Canada."

Shale gas producers in the U.S. also face heightened regulatory pressures, as public concern over the potential impact of hydraulic fracturing - or fracking - on public water supplies continues to mount.

The use of fracking - a process whereby water and chemicals are directed under extreme pressure into gas-bearing shale rock, thereby allowing natural gas to flow more freely - has triggered a public backlash in many U.S. states.

In a recent report on the growing U.S. shale gas industry, a panel appointed by U.S. Energy Secretary Steven Chu called for changes that could boost the industry's production costs significantly.

If so, that could slow the growth of new U.S. shale gas supplies, which have grown from almost nothing a few years ago to about 30 per cent of total U.S. natural gas production today.

The panel recommended creation of an industry group to encourage producers to measure and report air pollution, minimize water use and improve well casing and cementing. It also called for a national database to provide public information on the impact of fracking.

Although industry players say the use of fracking hasn't caused any major incidents, critics say the threat to drinking water supplies remains significant.

"Public concerns extend to accidents and failures associated with poor well construction and operation, surface spills, leaks at pits and impoundments, truck traffic, and the cumulative impacts of air pollution, land disturbance and community disruption," the report states.

"That (threat of tighter regulation on shale gas production) adds to the bullish argument on natural gas," says Schachter.

"If you have to spend more money making sure that the regulations are met, and you've got to inform the government on toxicity levels and check on all the water wells in the area before you drill, and make sure your casing is strong enough and deep enough to get beyond the water table, all of that adds to your operating costs."

Schachter's advice? It's time to get more bullish on natural gas.

He recommends switching out of oil stocks - which he says face more downside ahead as the peak summer driving season ends - and into selected natural gas stocks.

© Copyright (c) The Calgary Herald

Read more: http://www.calgaryherald.com/business/Analyst+fired+about+natural/5285052/story.html#ixzz1Vnh8UbPG