People love to call a bottom in the market, but, in my experience, this is a poor investment strategy. Perhaps when you see a turn in the market this might give you an indication that there is a rebound occurring, but one must be careful in any investment strategy to understand the fundamentals of why the price is high or low.
Looking at natural gas prices, we are currently hitting decade-low levels, but I would suggest to any investors hoping for a rebound to hold off, as there are some fundamental factors you should be aware of when looking at this investment strategy in energy. Energy prices are based on supply and demand, that is true; but, an interesting factor occurring in natural gas is a lack of storage capacity. With the new technologies developed in natural gas, the U.S. is producing a huge amount of supply. Combine that with the unbelievably mild winter and you have a situation where the supply of natural gas produced is not being consumed.
Inventory capacity in the U.S. is approximately four trillion cubic feet of natural gas. We’re roughly at 2.5 trillion cubic feet, almost one trillion more than the rolling five-year average at this point in the year. This means that we could fill our natural gas inventory capacity within a couple of months, leaving the market with a massive glut of natural gas. Some firms have stopped extracting natural gas, but not as many as you would think. Some are willing to pump at breakeven levels or even at a loss, because of the need to get cash in the door.
If we get natural gas inventory levels filled, we will be left with a situation where prices will plunge. Some analysts have even stated that prices could go negative, meaning suppliers will pay you to take their supply of natural gas. Personally, I’m not sure that will occur, but we’ve seen similar situations in other industries for a brief period of time. I do think we will most likely see further price pressure until the late summer and early fall. Hurricane season might change the fundamental dynamics and at that point we’ll also get a better read of what the winter will be like. Until that point, I would not try to pick a bottom in natural gas.
What I would look into are firms that use natural gas as an input. Chemical companies like The Dow Chemical Company (NYSE/DOW) are users of natural gas and will see that cost drop for the remainder of the year. Of course, costs are one side of the equation. One must also consider the earnings front. Utilities and power generation firms that have natural gas capacities will also benefit greatly this year from the lower prices. I am definitely staying away from coal firms, as they compete head-on with natural gas for electricity generation.
When making a long-term investment strategy in the energy field, don’t just go off the price because you believe it’s cheap or expensive. Everything is relative. Supply and demand dynamics play a huge role in the ultimate price that natural gas will fetch. With so much more supply of natural gas than can possibly be consumed this summer, it won’t be possible for prices to be bid up. Anytime natural gas prices rise, you will see producers sell their supply into the market. They have no choice; because, if they don’t sell their natural gas, there is no place to store it.