Natural Gas is Getting Ready to Explode

SIMON SAYS: Natural Gas Is Getting Ready To Explode

By SIMON CONSTABLE A DOW JONES NEWSWIRES COLUMN

Wednesday, September 16, 2009

NEW YORK -- After 14 months of price declines, the time may be near to get bullish on natural gas.

That will be hard for some to swallow given that inventories of the fuel have ballooned, more than halving prices in the past year to around $3.245 per million British thermal units, the recent rally notwithstanding.

Still, here's how we get to bullish and why some stocks might be worth a punt: There is a supply problem in the making.

The number of gas drilling rigs operating in North America more than halved compared with last year to 701 recently from 1,586, according to Baker Hughes Inc. (BHI), which compiles the data.

That could quickly become a problem. All it would take to bump demand up is a cold winter, an improving economy and an increased use of natural gas vs. coal by electric generators. Gas is considered greener than coal.

"Once demand does tick up, it can take weeks and months to get production back on line," said Matthew McCall, president of New Jersey-based investment advisory firm Penn Financial Group. "Reducing the number of drill rigs is like turning off a spigot that you can't (quickly) turn on again."

That still leaves a historically high inventory overhang: Stockpiles are now 17% higher than their average level over the past five years, according to recent data from the Energy Information Administration.

But the inventory problem is already reflected in low natural gas prices. It's likely not comprehended that gas storage units are getting clogged-up.

Once the storehouses are full, inventories can't grow bigger.

New York-based Standard and Poor's equity analyst Tina Vital said gas storage in the producing Gulf region is filled close to capacity. "In Canada it's even higher," she said.

Or in other words, the supply-demand balance can't get much worse.

It also means in the event of slower-than-expected demand even more rigs will likely be idled, so helping the bull case further.

Penn Financial's McCall said the price could hit $6.25 in 2010. And Shawn Reynolds, an equity analyst at New York-based money manager Van Eck Global, said he thinks that could be a conservative estimate.

How to play this? For those with a high tolerance for risk -- meaning you don't mind losing big if the upside is large, too -- Nymex-traded futures might be a good way to go.

But trading futures typically involves leverage, making them a dicey proposition for small investors. Leverage magnifies the gains and losses and can also result in investors losing more than they originally put down.

The United States Natural Gas (UNG) exchange-traded fund tracks the price of gas futures and overcomes the leverage problem, but it has a special wrinkle.

"I would have a problem doing it because it trades at such a premium to its (net asset value)," said Van Eck's Reynolds. Recently, shares were selling for about $11, a 16% premium to the underlying value of the ETF holdings of $9.12. Such a premium may be an aberration, but it probably pays to steer clear for the time being.

Instead, Reynolds favors drillers that are projected to expand production, such as Quicksilver Resources Inc. (KWK) or XTO Energy Inc. (XTO). He sees Quicksilver possibly doubling or tripling from the recent $13; while XTO could rally to as high as $55 from about $40 recently.