Private Client Group

July 6th, 2016

Investing Opportunity in US Natural Gas?

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Electricity is a lifeline of the modern world and its evolution is toward being produced ‘clean.’ Thanks to its clean burning, predictable and flexible nature coupled with a production boom and lower prices, natural gas has become an increasingly attractive fuel for the electricity generation. Evolving technologies will continue to enable natural gas to play an ever increasing role in the clean generation of electricity.

The early 1970’s saw a growth spurt in the use of natural gases largely due to its diverse applications and attractive prices. But, for most of the 150 years of U.S. oil and gas production, natural gas has played second fiddle to oil and coal. In the decades following the 1970s, natural gas didn’t re-emerge notably until 2003 when we saw cyclical demand in the U.S. rise highlighted in context of limited availability and multi-year ‘take or pay’ contracts emerge (agreements where buyers agree to either: 1) take, and pay the contract price for, a minimum contract quantity of commodity each year (‘TOP Quantity’); or 2) pay the applicable contract price for the TOP Quantity if it is not taken during the applicable year).

Over the years, as natural gas gained popularity in terms of its varied usage capabilities—eight of every 10 rigs were chasing gas targets. After 2003, and with the onset of the shale revolution, we saw both production and consumption of natural gas rise at a fast pace. Natural gas production increased from less than 50 billion cubic feet a day (Bcf/d) in 2005 to about 80.1 Bcf/d in February 2016; an increase of nearly 60% over 10 years. February 2016 recorded the second-highest production level ever, and there is no indication that this rate of increase is slowing. In fact, with continuing improvements in drilling efficiency and effectiveness, natural gas production is forecasted to reach almost 90 Bcf/d by 2020 (according to the U.S. Energy Information Administration).

On the consumption side, total natural gas consumption averages for 2016 stood at 76.5 Bcf/d compared to 75.3 Bcf/d in 2015. Despite a minor increase in consumption, adverse weather conditions, over-supply, record low oil prices and limited storage facilities have dampened natural gas prices (which have hovered around record lows achieved in December 2015 of $1.70 per MMBtu. The Henry Hub natural gas spot price averaged $1.92/million British thermal units (MMBtu) in April 2016, an increase of 19 cents/MMBtu from the March price.

Over-supply coupled with a warm 2015-2016 winter has resulted in low gas prices, but the scenario is expected to change in 2016 as we see a dip in the supply of natural gas. Overall dry gas production and imports have been on a decline since last October, and in the meantime exports have also gone up. As a result, it is expected by the EIA (U.S. Energy Information Administration) that the supply surplus that has existed since December 2014 will slowly disappear and move into a deficit by November 2016. This change in the demand and supply dynamic is expected to improve the overall economics of the U.S. natural gas market in the latter half of 2016 and 2017.

Henry Hub spot prices averaged $1.99 per MMBtu in the first quarter of 2016, but with a change in the supply and demand equation, prices are expected to double during the deficit period as seen during the last supply deficit from December 2012 to November 2014.

Bottom Line for Investors

A decade of declining natural gas prices has led to a decline in investor confidence. Lack of profit led many energy companies to divest natural gas assets and reinvest in oil instead. However, the tide seems to be turning as incredible reductions in drilling costs have made it possible for many natural gas wells to break even or turn a profit at current levels. Around 2008, 1,560 rigs were required to produce 2.9 trillion cubic feet of shale gas, but today only 189 rigs are giving 5 times higher production. Leveraging the benefits of game-changing technology is making the industry’s presence felt again.

A number of other factors are expected to drive demand for this reliable, cheap and abundant source of energy and provide a compelling long-term investment opportunity:

Disclosure

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. The information contained herein has been obtained from sources believed to be reliable but we do not guarantee accuracy or completeness. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.
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