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Time to add natural gas to your portfolio?
by Larry MacDonald, Canadian Business Online
Tuesday, September 15, 2009
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Natural-gas prices look so unsustainably low that it’s tempting to build a portfolio position in the commodity through natural-gas stocks or exchange-traded funds (ETFs) tracking the sector. Surely, the bottom is at hand and prices are ready to snap back?

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How much lower can they go?

How about to zero? That’s what briefly happened in 2006 to wholesale prices in the U.K, as the Financial Times of London reported. Producers ran out of space to store the stuff and had to dump output at whatever price was available in the spot market.

Recently, the price of U.S. natural gas (for October delivery at the Henry Hub pipeline node) plunged to a 7 1/2-year low of $2.508 (U.S.) per million British thermal units (down about 70% from a year ago). The trigger was a government report showing that producers injected another 65-billion cubic feet into underground storage during the previous week, bringing inventories 17.5% above their five-year average.

Now that North America is entering the period when neither air conditioners nor furnaces are operating much, the stockpiling is expected to get worse. In fact, analysts predict U.S. storage will go to overflow by October or November.

Canada is said to already be past capacity. Inventory levels in Western Canada have gone past the 489-billion cubic feet of existing storage capacity available, noted a report from Calgary-based energy consultancy, FirstEnergy Capital. The firm predicts Canadian natural-gas prices are headed down to under $1 per thousand cubic feet.

Why is there so much supply in North America? Technological advances in drilling for shale gas have increased extraction efficiency for this once hard-to-access source. Another reason is the expansion in physical infrastructure for importing liquefied natural gas (LNG) into North America.

You might think producers would cut back on production with prices so low. Some have (only 25% of available rigs in western Canada are active). But others continue to pump it out because they need revenues to meet interest payments on debt issued to increase capacity, invest in new technologies and expansion of terminals for importing LNG.

It looks like the supply glut could be corrected involuntarily, through a rash of bankruptcies of the more leveraged firms. Indeed, this process appears to have started: in the last few weeks, natural-gas firm Trident Resources Corp. filed for bankruptcy protection from creditors, listing as much as $10 million in assets against $1 billion in liabilities.

Investors can wait for the rebound by owning shares of natural-gas producers with low-cost operations and strong balance sheets. In this regard, Canaccord Capital Inc. oil-and-gas analyst Richard Wyman recommends: EnCana (TSX: ECA), Celtic Exploration (TSX: CLT), Progress Energy Resources (TSX: PRQ) and Fairborne Energy (TSX: FEL).

Or, investors may consider the United States Natural Gas Fund (NYSE: UNG), which tracks the commodity’s price in the U.S. However, UNG is presently trading at a premium of nearly 20% to net asset value because the ETF provider has stopped issuing new shares (due to regulators imposing a limit on positions in the gas futures market).

Perhaps the better option is the Claymore Natural Gas Commodity ETF (TSX: GAS), which tracks Alberta prices. It doesn’t appear to be trading at a premium, Canadian gas supply already exceeds storage capacity, and currency risk won’t be a worry (for Canadians).