Natural Gas In 2013: The Bull And Bear Case

For investors in the natural gas sector it certainly has been a tug of war the last few years. Prices for the fuel surged from a low of $1.96 per million Btus in early 2002 to a peak of $15.78 back in 2005 as the U.S. was predicted to be in short supply of the fuel. Since that time, advances in hydraulic fracturing (fracking) as well as horizontal drilling have helped unlock a virtual ocean of the natural gas within U.S. borders. That abundance has completely changed the supply landscape and has resulted in massive inventories of the fuel [for more natural gas news and analysis subscribe to our free newsletter].

The abundance of gas is so high that the price fell back to a low of $1.90 early last year. Investment vehicles such as the United States Natural Gas Fund (UNG) followed suit and touched new lows. Likewise, natural gas-focused exploration and production (E&P) firms’ share prices felt the same whip-saw as these inventories grew.

However, since re-hitting those decade lows, natural gas has shown some spark and has started to rebound. As we enter the New Year, the question on many investors’ minds is just what kind of market natural gas will see in 2013.

Bull Case

There’s certainly plenty to be bullish about when it comes to natural gas in 2013.

As prices for the fuel have continued to drop, many producers such as Chesapeake Energy (CHK) and EnCana (ECA) began to curtail production of dry gas, switching to more natural gas liquids (NGL) production. Those efforts have seemed to work and have helped reduce the sheer glut of the fuel. Prices for natural gas have finally started to rebound slightly, and they hit $3.90 just before the end of the year [see also 25 Ways To Invest In Natural Gas].

Those rebound prices are coming just as demand for the fuel is set to rise.

Natural GasFirst, natural gas is quickly becoming the feedstock du jour for various industrial and chemical manufacturers. Produced alongside natural gas, ethane is a vital ingredient for the petrochemicals sector. NGL is sent through a refining process and “cracked” similarly to crude oil, producing one of the most basic of commodity chemicals: ethylene. Ethylene is a key component in a variety of plastics and products we use each day. More importantly, it’s cheaper to make ethylene via natural gas than it is with oil.

That gives petrochemical firms a huge incentive to build new “crackers” here in the U.S. and take advantage of the fuel. That growing demand should help push up prices.

At the same time, using natural gas as a way for utilities to generate electricity continues to rise. Roughly 90 GW worth of power plants are set to retire by 2020. At the same time, recent EPA rules have made owning coal-fired plants pretty prohibitive for utilities. That means natural gas is being pushed as the prime source generation. Every 10 GW of generation capacity will require an additional 1.2 billion cubic feet of natural gas per day.

Finally, U.S. producers may get their chance to become major exporters of the fuel. The Department of Energy has recently started approving massive new projects for new liquefied natural gas terminals (LNG). These plants will be able to ship our abundance of exports overseas and should help reduce the glut here at home.

Bear Case

Not everything could be rosy for the fuel in 2013. While improving demand dynamics are there, natural gas does have some blemishes on its face; the biggest of which could be the weather.

So far, this winter is looking like a repeat of 2012, when unseasonably warm temperatures sent the fuel down to record lows. Across the Northeast, temperatures in December averaged roughly 8 to 10 degrees above normal, while around two-thirds of the U.S. saw unseasonably balmy weather. Those higher-than-normal temperatures will put pressure on the fuel as heating demand wanes. About half of U.S. households use natural gas for heat.

Believe it or not, coal may get the last laugh. Coal prices have gotten so cheap that if natural gas rises above $3.40 this year, analysts estimate that utilities would add roughly 50 million tons of coal demand, despite any EPA regulations. The DOE predicts the amount of electricity generated by coal will actually rise in 2013.

Additionally, despite any recent production cuts to drilling by, natural gas production is expected to rise by 0.5% this year as regions like the Marcellus now have new pipelines connecting their wells. At the same time, drillers have finally started shifting rigs back towards dry gas. All in all, any boost in supplies could hurt the delicate balance natural gas needs to rise.

The Bottom Line

For investors, both the bull and bear case can be made for natural gas over the next year or so. Supply and demand for the fuel will remain tight and any shift either way could cause prices to fall or rise. Investors in funds like the First Trust ISE-Revere Natural Gas (FCG) may find themselves suffering in the short term; however, over the longer term, the future looks bright for the fuel as some of the demand drivers really take hold.

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Disclosure: No positions at time of writing.

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