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The story in one energy market is that, after a long period of downward sloping prices, the great rebalance is finally underway. Supply and demand are finally aligning in a way that will push prices strongly upward.
But I’m not talking about oil, where an overabundance of oil remains a problem.
The market in question is natural gas. And market participants have begun to notice.
Natural gas prices have surged to an 18-month high and are now nearly 44% higher (more than $1 per million BTU) than the February low.
The Great Rebalance
The reason is very basic as it often is with commodities. The low prices of the past few years has translated to rising demand and shrinking supplies.
U.S. natural gas production has been falling since April. Production in July, for example, was nearly 4% lower than a year earlier. Drilling has slowed almost to a crawl. According to Baker Hughes (NYSE: BHI), the number of rigs drilling for gas fell to just 81 in early August from 213 a year earlier.
At the same time, domestic consumption of natural gas is rising.
Much of that is due to the permanent switch-over by utilities from coal-fired power plants to those powered by natural gas. U.S. power producers had 448 megawatts of gas-fired generation capacity in July. That was 25 gigawatts above the level at the end of 2012.
And the trend will continue. Another 11.5 gigawatts will be installed by the start of 2018. That means a nearly 10% increase in gas-fired power generation capacity just since 2012.
Of course, weather was a factor too in the higher demand this year. This past July saw utilities pull natural gas from stockpiles in the first summer drawdown in a decade.
A hot July nationwide resulted in power producers burning a record 1,184 billion cubic feet of gas. Citigroup analysts said that electric power demand was 4.5 billion cubic feet higher than in July 2015.
Finally, gas exports have hit record levels this year thanks to both new pipelines and new LNG (liquified natural gas) export terminals.
Natural Gas Inventories Dwindling
The result of all this can be seen with even a cursory glance at natural gas injections into underground storage facilities. By March, these inventories stood at nearly at 2.5 trillion cubic feet. That was the highest on record for the end of winter.
Natural gas stocks typically rise in the period between April and October. Then draw down between November and March as natural gas is burned for heat in the winter.
This state of the market has changed a lot though since the end of March.
Natural gas inventories have risen by less than the five-year average every week since May. In the 10 weeks through September 23, injections were 50% less than the rate just a year earlier.
That has changed the supply/demand equation completely. At the end of March, stocks of gas stood at 1,014 billion cubic feet above the prior year’s level. By the end of the first week of October, that had shrunk to only 28 billion cubic feet.
In simple terms, the natural gas market has moved from a huge oversupply to near-balance. And is forecast to be in deficit in 2017.
Natural Gas Investments
How can investors position themselves to play the pending deficit in needed natural gas supplies?
The purest play among natural gas investments is through the purchase of exchanged traded products that own natural gas futures.
The issuer of my two favorite such vehicles is US Commodity Funds. The first fund is the United States Natural Gas Fund LP (NYSEArca: UNG), which holds near-term contracts on natural gas. The second is the United States 12 Months Natural Gas Fund (NYSEArca: UNL), which holds gas contracts every month out to one year.
With me residing in western Pennsylvania, I would be remiss not to mention a few natural gas producers here in the prolific Marcellus shale.
Among the top producers I like are: the No. 3 producer Rice Energy (NYSE: RICE), which recently purchased the No. 6 producer Vantage Energy and Consol Energy (NYSE: CNX), which has been steadily divesting its coal business to focus on natural gas.
The two companies’ stocks are up 53% and 70% respectively over the past 52 weeks.
Unlike with oil, I am very bullish on natural gas and natural gas investments. I expect the fundamentals to remain favorable for the foreseeable future.