After surging above $13 per thousand cubic feet (Mcf) in 2008, natural gas prices have never recovered. They stood at $6 per Mcf at the end of 2010, $4.75 by the end of 2011 and now sit just above the $3 mark.
Still, that's seen in a bullish light when you consider this commodity plunged below $2 per Mcf last spring. Here's the good news: A series of mid-decade catalysts could help push natural gas prices back to $5 per Mcf, making this a good time to brush up on the savviest gas-focused investments.
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Supply in check, here comes demand
As a quick recap, gas prices plunged as production soared. Simply put, supply has overwhelmed demand. Yet in the past year, gas producers have sobered up and the number of rigs in service in the United States has fallen by 50% in the past 15 months. Production hasn't fallen to the same extent, as the existing base of the current roughly 440 rigs in service has been quite productive. Still, the reduced rig count has helped to shrink the amount of natural gas in storage from a peak of 934 billion cubic feet (Bcf) above the five-year average (seen last spring) to a recent 320 billion, according to UBS.
Looking out during the course of 2013, the rig count should remain in check: "After guiding their own production higher for years, companies are now more forcefully guiding to lower production in coming quarters," wrote analysts at Goldman Sachs in a Dec. 13 note to clients. As a result, look for gas production to remain in check, and for gas prices to stay firmly above $3 per Mcf in the quarters ahead (unless we get an unusually mild finish to the winter heating season).
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Yet if you look past 2013, then the entire picture starts to change. Starting in 2014, a series of distinct catalysts will come into focus to help guide a steady surge in demand and lead to a 50% rebound in gas prices. These catalysts include:
1.2014: New petrochemical plants that are now under construction will come online as global chemical companies look to shift production to low-cost shale regions in the United States.
2.2014-2015: A number of aging coal plants are slated to be retired, leading to a continued migration toward gas-fired power plants.
3.2015: Truck engine makers are expected to roll out fresh designs that enable fleet operators to run on diesel or (much cheaper) natural gas.
4.2016 and beyond: One or several new export facilities are expected to come online in the U.S. Gulf Coast, leading to a steady surge in gas exports.
It's no wonder my colleague Andy Obermueller, chief strategist of Game-Changing Stocks, says the United States "will run on natural gas" in the next few decades. (He's actually putting the finishing touches on a special report on this topic right now, including the names and ticker symbols of the companies that are set to profit from this trend.)
Here's a quick look at the liquefied natural gas (LNG) export plants that are being contemplated or already under construction:
Roughly 14 Bcf of export capacity is planned
In the past few years, a number of firms have been looking at building new gas-export facilities, although it was unclear whether the U.S. government would allow industry operators to absorb such a huge amount of supply for exports. But in December 2012, NERA Economic Consulting looked at the economic effects of these projects for the U.S. Department of Energy and found that "Across all these scenarios, the U.S. was projected to gain net economic benefits from allowing LNG exports. Moreover, for every one of the market scenarios examined, net economic benefits increased as the level of LNG exports increased. In particular, scenarios with unlimited exports always had higher net economic benefits than corresponding cases with limited exports." This conclusion undercuts the argument that gas exports would be harmful to the U.S. economy.
Assume some of the projects outlined above never come to pass. Even if only a handful of these plans come to fruition, then the United States may be exporting roughly 4-5 Bcf per year by 2016 or 2017. And this could alter the current supply and demand equation meaningfully. In 2013, supply and demand are expected to reach roughly 63 Bcf and an increase in demand from our exports is likely to push gas prices higher toward the $5 per Mcf mark.
Why that figure? Because any move above $5 would likely trigger an increase in gas production, or a switch at power plants back to coal. Still, such a move implies a 50% gain from current price levels.
Gas on the roads?
Exports are looming as a solid catalyst in this sector, but my colleague James Brumley recently pointed out the opportunities shaping up in the transportation sector as well.
You may also want to check out this discussion between Bog Bogda and Nathan Slaughter, which focused on the savviest gas producer plays right now.
Risks to Consider: The biggest near-term risk for gas prices is a mild U.S. winter. A long-term threat is falling oil prices, which would crimp demand for natural gas-powered vehicles and could change the economics of gas exports.
Action to Take --> This industry is in flux, which always spells opportunity. A number of gas producers are sitting on productive shale acreage, including Cabot Oil & Gas (NYSE: COG), Encana (NYSE: ECA), Range Resources (NYSE: RRC) and Southwestern Energy (NYSE: SWN). I prefer the exchange-traded fund (ETF) route, so the First Trust ISE-Revere Natural Gas Index ETF (NYSE: FCG) appears to own a solid mix of leading gas producers.
-- David Sterman
David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of RRC in one or more of its "real money" portfolios.