Natural gas prices are trading at 20-year lows.
To put this in perspective, the last time natural gas traded at these levels President Bill Clinton had us questioning what the definition of “is” is … Google was not invented yet … And “Dolly the sheep” was the first mammal to be successfully cloned…
The crash in natural gas prices can be expected. New technologies — including hydraulic fracking and horizontal drilling — allowed drillers to produce huge amounts of natural gas in some of the biggest shale areas in America.
According to the Energy Information Administration (EIA), the U.S. is sitting on 2,543 trillion cubic feet (TCF) of natural gas reserves. This is based on the latest estimates available (from 2014).
To put this in perspective, America consumers roughly 27 TCF of natural gas every year. This means there is enough natural gas to supply U.S. consumers for 94 years (2,543 TCF / 27 TCF).
Before you run to short the natural gas sector, there is something you should know …
Demand for natural gas is set to surge in the years ahead. And several initiatives taking place right now will result in a ton of natural gas coming off the market.
These catalysts should propel natural gas prices — and most natural gas stocks — much higher from these super-depressed levels.
Let me explain …
Since 2008, natural gas prices have plummeted by more than 85%. As I explained, this is mostly due to much higher supply brought on by new technologies.
However, demand for natural gas is expected to surge in the years and decades ahead …
As you can see from the chart, natural gas will surpass oil and coal as the most-used fuel in the world.
Sure, this is expected to take a few years. But we are already seeing strong demand for the clean fuel as more and more countries switch from coal to natural gas for electricity generation.
In the meantime, there is a fundamental shift taking place in the natural gas sector …
Most producers stopped drilling for natural gas since it’s no longer economical at current prices. Plus, the money spent to find oil & gas is down significantly (by 23% from 2014 to 2015).
In 2016, investment bank Barclays (which has kept track of these stats for decades) predicts spending will fall by at least another 25% in 2016. To put this in perspective, we are talking declines of roughly $250 billion in production & exploration spending from 2014.
This steep decline in spending can be seen in the latest rig counts. According to Baker Hughes, the natural gas rigs fell to 94. This is down 88% from just four years ago (from 811 rigs to 94)!
In fact, Oil & Gas Journal says “the U.S. rig count is the lowest since the 1940s and perhaps in the infancy of the oil & gas industry in the mid-19th century.”
The massive declines in capital spending will eventually result in tons of natural gas supply coming off the market. We will also see our natural gas stockpiles fall as America begins exporting natural gas.
In 2014, the U.S. government passed legislation allowing for the exporting of natural gas. This opened the door for energy companies to build liquefied natural gas (LNG) facilities along our coastlines.
The first shipment of LNG was exported from the Sabine Pass facility (owned by Cheniere Energy) just a few weeks ago. Sabine Pass is one of 7 LNG-exporting terminals approved by the Federal Energy Regulatory Commission (FERC). There are another 22 applications pending.
Sure, some of these LNG facilities may take longer to build, with energy prices down sharply from 18 months ago. Plus, the cost to construct each facility could run more than $10 billion.
However, LNG shipping is a game-changer. It will result in more natural gas coming off the market since we can produce it at a dirt cheap price… and ship it to Europe and Asia at a huge premium.
This will result in the U.S. becoming a net exporter of natural gas for the first time in more than 60 years.
As you can see, global demand for natural gas is expected to rise sharply in the years ahead. This — coupled with huge supply of natural gas expected to come off the market — will result in much higher prices in the future.
To be clear … I am not calling for natural gas prices to jump from under $1.80/MMBtu into the double digits anytime soon. But I do expect prices to trade close to their historical norm of $4/MMBtu over the next 12 to 18 months.
If I’m right, that’s 122% higher than the current levels. And at $4, the price of natural gas would still be trading at a 70% discount to its 2008 highs.
As prices rise, most natural gas stocks should perform well. However, this does not mean you should buy just any natural gas producing company since several are having liquidity problems right now.
I suggest focusing on the ones with strong balance sheets and have at least 50% of their production hedged through 2016. This will provide some downside protection if natural gas prices remain near these record low levels for a few more months — before pushing higher.