Power plants typically have back up turbines powered on natural gas. In another example, the production of ethane for industrial uses is often determined via the price/value tradeoff of using natural gas or petroleum as a feedstock.
Due to natural gas’ secondary nature as a feedstock/fuel, demand is considered seasonal. Temperature extremes (hot or cold) put extra stress on the energy grid and cause providers to flock to natural gas as a way to control costs in the face of rising demand for petroleum and to quickly scale output to meet demand. Similarly, increasing industrial utilization eventually drives producers to choose natural gas as a feedstock for their processes.
As the summer months and potential supply shocks due to hurricane season approach, the time is ripe for natural gas to begin catching up. In 2006, the Department of Energy published a statistical study of natural gas and oil prices between 1989 and 2005, it’s findings were consistent with what we expect from the above mentioned characteristics of natural gas. As a secondary substitute to petroleum, long term natural gas and oil prices move with significant correlation to one another. Natural gas prices, however, tend to lag large changes in oil prices and their correlation is muted when oil price changes are transitory as opposed to permanent.
If you’re thinking about making a play at natural gas, the key question to ask is whether or not the current rebound in oil is here to stay? More fundamentally, this is a question of how significant and how rapid the rebound in industrial production in the United States will be. I won’t portend to be a master of economic and business indicators or to have a crystal ball, but what I do know is that having the benefit of watching oil and other commodities, betting on natural gas is not a difficult leap at all.
Full disclosure: Author has no direct positions in any of the funds and commodities mentioned in this post. Author is long shares of LINE, an oil and gas MLP, and VLO, an oil refiner.
