Thursday, July 23, 2009

Gas Prices, Inventories and ETFs

It’s no secret that natural gas prices have been in the tank this year. The combination of high supply and weak demand have been the main culprits, and the success of shale plays like the Haynesville Shale partially have been to blame on the supply side. I’ve been doing lots of reading on the subject lately and while there’s no real consensus, there seems to be a belief by many that natgas prices have bottomed. Earlier this year there was talk of $2 natgas by August, but that prediction might not come true (knock on wood, lots of wood).

In one article, an analyst, Peter Beutel of Cameron Hanover, commented that “the market has already discounted the high levels of natural gas storage and is beginning to focus (on) an inevitable drop off in supplies brought about by lower drilling activity.” I always find it scary when analysts start saying things like, “it’s already priced in there” or “the price includes the discount for XYZ.” Ultimately the prices in the markets for stocks and commodities are determined by the individuals on either side of the trades, a largely human interaction, and it is true that certain negative information is “priced in” to a trade. Still, it’s like the lifeguard at the beach during a shark alert announcing that it’s safe to swim. “We know about the sharks, but we’ve quantified the risk and it is priced into our call.”

The big news for Thursday is the release of the U.S. Energy Information Administration’s gas storage reports. That’s juicy news for traders. If the change in inventories surprises traders, expect the natgas prices to move one way or the other. FYI, the “consensus” estimate is an increase of 68 Bcf.

Another drag on natgas prices has been the natural gas exchange traded fund, UNG. The fund has been extremely popular since May 2009 because investors have been betting on an increase in natgas prices. They have been buying shares like crazy and the fund has run out of shares. The fund’s managers have applied to the SEC to increase the number of potential shares by six times, but the request, which was filed in early June, is still working its way through the SEC. I’m no good at explaining the exact mechanics of why many people believe the UNG share problem has been holding down natgas prices, but here is an article from the Financial Times discussing it in depth.

Ultimately, the thing that will help move natgas prices north is an increase in demand fueled by an improved economy.

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