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Some mainstream investors see the opportunity in natural gas [ClearOnMoney]
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Some mainstream investors see the opportunity in natural gas

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Commentary

Some mainstream investors see the opportunity in natural gas

1 Sep 2012 by Jim Fickett.

Last October Jeffrey Gundlach noted the opportunity in natural gas (Thoughts on current markets from Jeffrey Gundlach):

The all-asset class portfolio is currently legging into a long natural gas position - slowly. Jeffrey says it probably goes nowhere in the short-term but in a decade or two could be a five-bagger just like his gold trade was. Natural gas is very cheap and has a lot of potential in the long-term.

In February Jeremy Grantham noted the opportunity (Some practical investment thoughts from Jeremy Grantham):

Natural gas is, for most purposes like home heating and electric utility plants, a better and cleaner fuel than oil or coal, but is for technical reasons in distress: there have been several recent decades in which the BTU equivalent price for natural gas did, at least for a second, reach parity with oil. But now it is at just 14% of BTU equivalency, the lowest in almost 50 years. Everyone who has a brain should be thinking of how to make money on this in the longer term.

Now a staid Fidelity energy portfolio manager notes the opportunity:

Our fund manager believes natural gas prices may not stay low for much longer. …

There is a common perception in the market today that U.S.- produced natural gas is going to be cheap in perpetuity, and that F&D [Finding and Development] costs are in a period of structural decline due to the effectiveness of new hydraulic fracking technologies …

F&D costs for natural gas producers have not declined as many industry observers might have expected …

The price of natural gas relative to production costs is low …

Based on my recent analysis and the historical relationship between the price of commodities and F&D costs, my view is that the price of natural gas should move higher and come back in line with F&D costs

One simple measure of the so-called gas “glut” is the inventory of gas in storage, measured in months of supply. This shows a slight excess of gas, but nothing abnormal, and now apparently topping out again:

The stock prices of gas companies are quite low right now, but they may go even lower. Commodities in the ground can only be reported as reserves if they can be produced at market prices. That means 2012 reserves will be further marked down, and companies will have to take a (non-cash) charge to earnings for the loss of reserves. The real value of the gas in the ground, and of the company, will be unchanged, but this will affect sentiment, and possibly the ability to borrow. From the Financial Times:

Last year, the Securities and Exchange Commission wrote to dozens of shale gas companies, calling on them to clarify how they had been reporting their reserves. …

“This round of reserve cuts is going to be more embarrassing for some companies than for others,” said Duane Grubert, an analyst at Susquehanna Financial. “The guys who were too aggressive in booking reserves are going to stick out like a sore thumb.”

US independent oil and gas companies including Anadarko Petroleum, Ultra Petroleum, Southwestern Energy and Quicksilver Resources reported non-cash charges for the second quarter of 2012, reflecting writedowns of the values of their gasfields.

At the end of the year, more companies are likely to follow suit – reporting not only the declining value of the assets but also shrinking volumes of proved reserves. …

Companies that are forced to make writedowns can also come under financial strain, because oil and gas banking covenants typically link borrowings to reserves. A company that suffers a decline in its reserves may be forced to renegotiate its credit lines or sell assets to raise cash.

(For sources, background and previous commentary see the Reference page US natural gas supply.)