It looks like the U.S. Energy Information Administration (EIA) got it right when it predicted natural gas would rise:
“The projected Henry Hub [natural gas] spot price this winter averages $4.00/MMBtu compared with $4.52/MMBtu last winter,” the EIA noted in its October Short-Term Energy and Winter Fuels Outlook. “Nymex Henry Hub natural gas futures price for delivery during January 2015” are expected to average around “$4.19”, it postulated.
And where did Nymex Natural Gas finish the day yesterday? At $4.194. Yet this is much sooner than the forcasted January time frame. Does this mean it can go even higher still?
You bet. As the EIA estimated, “There is a 31% chance the price of natural gas will be above $4.50, a 14% chance it will rise above $5, and a 5% chance it will rise above $5.50 come this January”.
Yet recent weather forecast updates could see prices top $6 as some anticipate a repeat of last winter’s deep chill.
One way investors might capitalize on any continued move in gas prices is to purchase shares of a natural gas ETF. But there just might be a better way that might seem counter-intuitive at first glance: investing in gas utilities.
Let’s first see what’s behind the recent move in gas and what we might expect going forward.
Two Reasons Why Gas Should Move Higher
The main reasons why natural gas has been moving higher are also counter-intuitive: overproduction and warmer than expected winter forecasts. Yes, this is counter market forces. But don’t bail-out here. Read on.
First came the increased production which created an oversupply. “Natural gas production gains contributed to record storage injections this year,” reported the EIA in its early October report.
Next, came a warmer winter forecast. “Forecast temperatures are much warmer than last winter east of the Rocky Mountains with the Northeast, Midwest, and South about 11%, 16%, and 12% warmer, respectively,” the EIA’s report predicted. Similar warmer winter forecasts by other firms had been released as early as September.
Add the increased supplies with warmed forecasts and you get downward pressure on natural gas prices, as the EIA explained: “Growing production and record storage injections this year helped lower the 2014-15 winter futures prices (Nov. 2014 – Mar. 2015) for natural gas at Henry Hub from almost $5/MMBtu in late April to near $4/MMBtu in [early October].”
The drop in the natural gas price is noted in the graph below, where natural gas can be seen plunging 24.34% from $4.807 on June 16th to as low as $3.637 on October 27th less than two weeks ago.
Source: TradingCharts.com
But natural gas wasn’t the only price to drop. Gas utilities and ETFs fell too, as graphed below spanning June 16th to October 14th:
• Gas utility AGL Resources Inc (NYSE: GAS) [orange] down 2.5%
• Gas utility National Grid Plc (NYSE: NGG) [blue] down 5%
• Gas utility CenterPoint Energy, Inc. (NYSE: CNP) [purple] down 7.5%
• Gas utility Cheniere Energy Partners (NYSE: CQH) [yellow] down 13%
• Gas utility ONEOK Inc. (NYSE: OKE) [beige] down 17.5%
• First Trust ISE-Revere Natural Gas ETF (NYSE: FCG) [black] down 40%
Source: BigCharts.com
Why were utilities falling too? The warmer weather forecast means customers will be burning less gas to stay warm, lowering sales revenues.
The EIA foresaw this too, indicating in its report that “projected changes in average U.S. household expenditures from last winter are 5% lower for homes that heat primarily with natural gas.”
Thus, investors went dumping not just natural gas ETFs like FCG, but also most of the gas utilities.
Yet the oversupply of gas on the market, warmer weather predictions and the dumping of natural gas ETFs and utilities by investors has set us up for a perfect storm to the upside, which we have been witnessing over the past two weeks already, with plenty more upside expected.
Investors Have Gas Right Where They Want It
The oversupply of gas and the warmer winter forecasts have worked in investors’ favor by driving down the price of gas to a one-year low not seen since mid-November of 2013. This is right where we want the gas market to be: low prices, the belief that the winter would be warm, and the belief that stockpiles would be enough to see us through.
With the trap all set up, all we needed now was a little scare to spook the natural gas market. And we got it.
“An early winter chill has flipped a down market,” the Wall Street Journal reported yesterday. “Commodity Weather Group LLC said Wednesday that Chicago, one of the country’s largest markets for gas-fueled heating, will see temperatures dip into the teens as the cold spell peaks in the middle of next week. Even parts of Texas, including the Dallas area, could see temperatures in the 20s.”
Old man winter here already? That took everyone by surprise, prompting the forecasters to return to their charts and gas traders to their pits.
“Natural gas traded at its highest price since July early Wednesday [yesterday] as cooling weather forecasts and rising demand expectations push a rally into its seventh session,” WSJ added. “December forecasts grew colder this week, too. That has traders worried about a repeat of last year’s historic cold, which led to record demand and prices above $6/mmBtu at the benchmark Henry Hub.”
“Another cold winter, combined with lower [supplies] than last year could lead to even larger price spikes than last year,” noted economics research firm Capital Economics in its commodities newsletter yesterday.
How did the utilities respond to this early cold snap and the potential for colder weather than was earlier predicted? Very nicely indeed, as graphed below spanning October 14th to yesterday:
• Gas utility AGL Resources Inc (NYSE: GAS) [orange] up 5%
• Gas utility National Grid Plc (NYSE: NGG) [blue] up 6.5%
• Gas utility CenterPoint Energy, Inc. (NYSE: CNP) [purple] up 10%
• Gas utility Cheniere Energy Partners (NYSE: CQH) [yellow] up 12%
• Gas utility ONEOK Inc. (NYSE: OKE) [beige] up 5%
• First Trust ISE-Revere Natural Gas ETF (NYSE: FCG) [black] up 5%
Source: BigCharts.com
Investors Utilize Utilities
Yet perhaps even more noteworthy than how quickly natural gas prices can turn around with a few forecasting changes is how the gas utilities performed both on the way down and on the way up.
On the way down, the utilities fell less than natural gas ETFs, since utility companies have monopolies in their own regions and a “captive” customer base that simply cannot get their electricity, heat or water anywhere else. Hence, utilities always have a stream of revenue that is pretty much reliable; more so than other non-monopolistic enterprises.
Yet their performance while gas has been rising has been a little surprising, since utilities do not capture upside moves in their underlying commodities very well as rising commodity prices add to their costs.
But in this case the rise in natural gas prices was so fast that it gave the gas utilities a fantastic edge. Throughout the summer, as gas prices were falling, the utilities had the great fortune of being able to lock-in future gas supplies for the coming winter at fantastically low prices below $4 per MMBtu since mid-July.
Yet now with colder weather expected to increase gas consumption, the utilities will not only sell more gas but will be able to raise their prices as well, which the EIA already expected would happen even when the winter was believed to be warm.
“EIA expects higher prices this winter for homes that heat with natural gas and electricity,” it predicted in last month’s report.
Thus, the gas utilities are at the beginning stages of a perfect storm: low gas prices locked-in over the summer, colder than expected weather forecasts indicating increased gas sales, and pre-scheduled higher prices which will increase revenues all the more.
If that weren’t enough to make investors happy, gas utilities offer some of the best dividends on the market, with the above mentioned companies paying among the best in the industry: GAS yielding 3.6%, CNP yielding 3.9%, OKE yielding 4.2%, and NGG yielding 6.2%.
All we need now is for Russia to keep its threat to block gas sales to Europe and the gas trading pits will simply explode.
Joseph Cafariello
