The last time this happened, investors had the chance to pocket 83% gains in about four months time.
They could have done it safely. This has nothing to do with the overall market direction.
Best of all, it’s consistently lucrative. It has paid off an average of 112%.
But it doesn’t happen often. This opportunity has only arisen three times in the last five years.
Right now it’s about to happen all over again. Here’s the set up.
Physics 101: Energy is Energy
Oil prices have been steadily climbing over the last few months.
Since the start of the year oil prices have climbed more than 5%. The combination a recovery in demand, OPEC successfully capping output, turmoil in Iran, and artificially low interest rate-fueled speculative buying has pushed oil above $80 a barrel.
Natural gas, on the other hand, hasn’t fared nearly as well.
Large stockpiles, exceptionally warm weather, and a host of other factors have helped push natural gas prices down. So far this year natural gas prices are down 28%.
A situation where oil prices go up and natural gas prices go down cannot and will not last.
You see, oil and natural gas are highly correlated over the long run.
It’s basic physics. Oil and natural gas are both hydrocarbon energy sources. When they are burned they produce a certain amount of energy. The energy values of each do not change. The energy value of a barrel of oil has always been the equivalent of about six thousand cubic feet (Mcf) of natural gas.
As a result of the value of the energy, oil and natural gas prices have been highly correlated over the long run.
The short-term, however, is a much different story. Sometimes events like cold weather, hurricanes, or other factors push natural gas prices higher and oil holds steady. Other times oil prices will climb when OPEC cuts production or during periods of heightened geopolitical turmoil while natural gas prices hold steady.
Since oil and natural gas prices are so volatile, the ratio of oil and natural gas prices varies greatly.
This volatility naturally creates opportunities. And it creates great opportunities for disciplined investors patient enough to wait for the extreme situations.
Right now, the oil and natural gas markets have hit one of those extremes.
The long-run oil/natural gas ratio tends to stay within a range between 6-to-1 and 12-to-1. That means the price of a barrel of oil is usually is the same as six to 12 Mcf of natural gas.
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The thing about oil price is that it is more susceptible to global demand, global events, and also currency strength. Domestic natural gas prices are more driven by regional demand and are not remotely influenced by currency strength. If there had not been the recent breakthroughs in unconventional gas production (tight sands and shale gas) the supply and demand balance for natural gas in the US would be very different than it is today.
Countries like Japan which have little domestic energy production rely on imported oil and imported LNG. If you were to look at the price Japan pays for LNG imports then you would see that the 6:1 ratio still holds pretty true.
Many companies thought that natural gas demand in the US would exceed production and built LNG import terminals (which are now very under utilized). This was before the breakthroughs in unconvention gas production. The only reason that any LNG cargos actually make it to the US is because the same companies also built massive LNG export facilities around the world. Due to the worldwide economic slowdown these LNG cargos don't really have anywhere to go and the cargos that do come here barely make a profit.
The natural gas market in the US is saturated. Production exceeds demand and is still growing (and will continue to grow for many years). The F&D costs for many of the new shale plays are between $1 & $2 (that's in the best rock, there are 10's of TCF's of natural gas that can be produced in even poorer quality reservoir with $3-$5 F&D costs). When the economy recovers and manufacturing output picks up, there will still be plenty of domestic onshore natural gas to meet this country's needs.
Even if a major hurricane affected GOM production, there is so much surplus production at the moment, it's hard to imagine a sustained spike past $6 for natural gas. Initial market reaction would quickly give way to reality.
Do not bet on a big natural gas spike when you try to make money investing in a natural gas producer. Instead look for a company that has a strong balance sheet and can grow production in a $4 to $5 price environment.
Exco seems well positioned to grow in the current price environment.
All valid point's , I can't disagree with any of it. Natural gas goes through boom and bust cycles, we are in a bust cycle. Natty stocks bottomed out Nov. 2008 and again March 2009 and now we have the reality of inventory[ storage ] and cycle is bottoming now. Going forward we need less production and we are seeing that somewhat . The shale play producers can ramp up production in a hurry so $7 or $8 natural gas is looking like a pipe dream, $6 could happen , not too many drillers are going to spend millions per well when NG is $3 to $4 except in the Haynesville, XCO has a cost basis around $.75 so that is a sweet spot for them but other players in the Haynesville will do the same so they will all contribute to over supply.
The Haynesville may turn out to be an industry curse.