Natural gas prices dropped to a 7-year low today, as NYMEX Henry Hub futures (for September) fell 17 cents to $2.95, breaking the $3 barrier. Natural gas has taken a drastic turn in decoupling from the price of oil after the financial crisis. Historically, a barrel of crude oil has traded at a 6-10 multiple of the price of one mmbtu of natural gas. However, during the last half-year, the price of oil has re-inflated to $70 while natural gas has languished at $3/mmbtu due to negative fundamentals.
The drop in natural gas seems strange considering the number of rigs drilling for natgas have dropped by 58% since September 2008, according to Baker Hughes. With conventional production dropping, how come the US department of energy expects stockpiles to reach a record 3,800 mmbtus in November? The reason, according to BoA/ML Energy, is unconventional production from shale has become more profitable. Some producers report being able to find costs as low as $1.5/mmbtu, allowing them to lock in substantial margins with January 2010 futures trading at $5.47/mmbtu.
Considering these economics, natural gas is likely to fall further in the short term as inventories continue to swell. But this cannot go on forever. Due to the difficulties of storing natural gas, storage space is very limited. As inventories rise, the price of storage will rise, pressuring the natgas forward curve towards backwardation. Another risk is regulatory action from the CFTC. The CFTC is holding hearings on whether to limit some dealers' positions in natural gas. This could cause temporary selling pressure as funds decrease their positions.
While there are strong reasons for low natgas prices in the short term, there are good reasons to be bullish on natgas in the long term. One of the best reasons is cap-and-trade. Climate change legislation promises to raise the price of coal and oil relative to gas (gas has lower carbon emissions). In terms of electricity generation, the price per MWH for natural gas will converge closer to that of coal, increasing demand for natgas. In terms of transportation, increased use of liquefied natural gas (as the Pickens Plan promotes) instead of oil will obviously raise demand, as will the increased use of electric cars. I would not be surprised to see natgas trading at $6-7 /mmbtu in 2010, though the long-term future of natural gas ultimately depends on the sustainability of the economics of shale production.
