Natural gas prices have hit rock bottom. You heard it here first. Or they haven't. But it's definitely one or the other and that's a fact.
It doesn't matter, because natural gas is a buy. It's not going lower. Unless it is. But again, it doesn't matter because ultimately it has to go up.
There's no way that gas can trade so cheaply compared with oil on a long-term basis. In the oil patch they use a six-to-one ratio to calculate equivalent barrels of oil. Gas is measured in mcf - thousands of cubic feet. Six thousand cubic feet of gas is treated as a barrel of oil when describing production and reserves.
Why 6,000? Because that's roughly the energy equivalent of a barrel of crude oil. To an energy user, then, they are roughly equivalent, so why should one be so cheap compared with the other? Natural gas is about $3/mcf while a barrel of oil is more than $70 (U.S.). Let me give you an analogy as to why this has to change. Take a Canadian stock that's traded in both New York and Toronto. Assume the U.S. dollar is worth twice the Canadian dollar. The stock should trade for half in New York - i.e. in U.S. dollars - what it changes hands for in Toronto, right?
But let's say it trades for the same amount, call it $10. Traders will immediately buy the stock in Toronto, sell it in New York, convert their greenbacks to Canucks and pocket the difference - risk free. That's an arbitrage, and arbitrages are rare and fleeting because they are quickly resolved by trading pressures. In this case, the excess buying in Toronto will drive the price up while selling in New York will drive it down to the point where the shares trade where they should on the respective markets.
I figure there has to at some point be an energy arbitrage, where oil goes down or gas goes up or some combination of the two. Of course, a share is a share, no matter where it trades. It's identical regardless of market.
A barrel of oil is not the same as a barrel equivalent of natural gas even if they do have similar energy content. Such price differences on an energy basis aren't new, and they don't go away quickly like an arbitrage in the stock market.
But, over time, that price differential has to close, because energy consumers are rational and to the extent that they can switch, they will. That extent is limited to a point, but given time for attitudes and technology to adapt, it gets bigger. The crude to gas ratio is exceptionally high.
That alone is reason enough to suspect a change. But as I've argued here before, there are other factors at play, notably the greening of the grid. The Obama administration wants to reduce greenhouse gas emissions by 80 per cent by 2050. That's clearly not going to happen, but if they are serious, they will have to substitute gas for coal and oil. Yes, natural gas warms the Earth too, but not as much. Talk of any other fuels on a widespread basis is silly. Tens of billions of dollars have given wind and solar a fraction of a per cent of market share in energy consumption.
So is the United States serious? Seems that way. In April, the Environmental Protection Agency withdrew an air quality permit it had issued for a 1,500-megawatt coal plant, effectively putting a stop to the project. Another plant was cancelled in Michigan the next month. Since 2001, 97 proposed coal plants have been shot down and nine so far this year alone. Not all will be replaced by natural gas, but my guess is many will.
There's no question that new technology and new finds are flooding the market with lots of gas and that prices aren't likely to spike up to where we've seen them even this decade. But just about everyone I talk to in the energy business says gas prices are unsustainably low and have to rise substantially before new production comes on stream. Meanwhile, Barclays Capital says, U.S. production has been falling since February. "At this point," the investment bank says, "declines in production have only begun."
There are lots of good deals in gas. Shares of companies with good balance sheets are available. And, more discreetly, I know of some desperate producers trying to auction off big pieces of themselves to the highest bidder.
So buy gas. Whether or not this is the bottom, it feels like we're very close.
Fabrice Taylor is a chartered financial analyst.