THE OIL:GAS RATIO IS AT 19 YEAR HIGHS
The price spread between natural gas and crude oil hasn’t been this high since 1990. Is a natural gas long position every buy and hold investors dream? Goldman Sachs doesn’t necessarily believe so:
Closing: Long oil/gas ratio trade
While demand stabilization in the petroleum markets has slowed the build in petroleum inventories and, consequently, has lent support to crude oil prices, natural gas prices remain under pressure. This has been particularly the case as cooler-than-average temperatures led to lower demand and associated higher than expected natural gas
inventory builds. Although we continue to expect the oil/gas ratio, currently at 20.7 in the prompt (September) contracts, to increase further between now and the end of the
summer on the back of improving oil timespreads, we believe this is a good exit point for
this trading recommendation. This is especially so given the downside risk we currently
see for long-dated oil prices, which are currently above our estimated marginal cost of
production. Hence we are now closing our long oil/gas ratio trading recommendation at a
total profit of 3.37.
A large hedge fund disagrees with the Goldman position. This intriguing trade crossed my desk yesterday. Apparently an undisclosed big player is betting on much higher Natural Gas prices in the coming moths. The FT reports:
A hedge fund has made a large bet that natural gas prices will triple by winter just as the price of the commodity slides to a seven-year low.
Traders took notice last week when the fund, as yet undisclosed, spent millions for the right to buy US natural gas at $10 (£6.03) per million British thermal units in January and February, up from Wednesday’s spot level just above $3 per mBtu.
“This is the first bullish play I’ve seen in quite a while,” said Raymond Carbone, president of Paramount Options on the New York Mercantile Exchange floor. “It caught the eyes of people in the [options] ring.”
The bet echoes purchases of call options – contracts that give the holder the right to buy at a fixed price and date – in late 2007 to cash in if oil moved to $150 a barrel by mid-2008.
The options were referred to as “lottery tickets” at the time because of their low cost and high potential reward, but the move paid off when oil surged.
US gas futures on Wednesday fell to $3.049 per mBtu, the lowest in seven years, as the market remains over-supplied. However, some say there is potential for a recovery once drilling rig shutdowns due to weak demand over the past year start to bite.
Ben Dell, an analyst at Bernstein Research, said that with US natural gas output falling 30 per cent this year, the steepest rate ever, a glut will turn into a deficit and prices will rise. But forecasters do not expect the market to hit $10 per mBtu soon.
Yet the hedge fund sees a chance of a spike. For months, an average 2,000 gas call options have traded each day for the New York gas benchmark contract. Last week, however, volume spiked one day as 10,000 January $10 calls were bought. Over the next two days, nearly 8,000 February $10 calls traded.
The slim chance of reaching double-digit territory was reflected in the price of the call options. January calls sold last week for about 5.6 cents, meaning that buying 10,000 contracts cost $5.6m.
Chris Thorpe, at Hudson Capital Energy, a New York options dealer, said the fund could be a winner even if the spot price did not reach $10. “If a 5-cent option goes to 10 cents, they’re happy,” Mr Thorpe said.
Is there a way to play this? Short oil long gas seems too obvious and fairly risky. Can you short the ratio?
The large natural gas producers have hedges in the futures markets on low prices of gas for the immediate-moderate term future. So they are continually producing a lot in order to kill the smaller/medium companies and will buy these companies up. I mean, the fact is, if you went and bought natural gas now and stored it, you would make money eventually. If you went and bought the natural gas etfs (UNG and GAZ), not so certain. These etfs have had poor performance in relation to natural gas movements (such as GAZ being up 4% yesterday when natural gas tanked), not to mention contango and fees that occur with energy etfs. I mean, natural gas will go up when storage is all filled and big financial firms want it to go up based on ‘this’ or ‘that’. I’d rather buy a small cap financially stable natural gas producer to play a natural gas run up rather than buy any crap etfs…
James,
What natural gas producer would you invest in if you have to pick one?
Jenny,
I have become a huge fan of the natural gas trust FCG. Could be a smooth way to play the potential upside in natgas while taking a fairly conservative bullish equity position.
Good luck.
The guy who runs Contango Oil & Gas (MCF) is like the Warren Buffett of the natural gas industry. Get this: He buys his stock back when it’s low and issues shares when it’s high. I know. I didn’t believe it either.
TPC:
This is my first comment here. I have been a silent spectator for almost 10 months now. I enjoy reading your site each and every day!
I currently have 225 shares of UNG at $12.61/share. I have a buy order for 400 shares at $9/share. The bear market of UNG has been worse than anything other than the Great Depression.
TPC, do you have any idea of buying into NG in the near future ? Is it not a good buy ?
KKR,
Nice to finally see you commenting! Glad you’re enjoying the site. Unfortunately, the supply on the market is unreal so further downside and volatility should not come as a great surprise, but I like gas as a long-term holding in ones portfolio. $3.30 natgas will look cheap in 10 years.
I hate UNG for the reasons James mentioned above. It is terribly inefficient for long-term holdings and causes all sorts of issues when you get that nasty k-1 at the beginning of the year. If you’re going to play the NatGas market you have to use futures or equities. FCG is my favorite way to buy into the nat gas stocks.
Personally, I have no holdings in anything natural gas related so I am not exactly talking my book here. If I were playing the energy markets I’d probably be more inclined to stick with oil….Natural Gas has too many negative trends developing around it in the near-term, but the outlook into 2010 should be much better. Perhaps consider initiating a small position and adding to it in late winter? Just some thoughts. Good luck.
TPC,
Can you comment on this article that I just came across…”Natural gas’s dirty little secret”…https://rigzone.com/news/artic I like to know what you or other readers think of it. Thanks in advance.
I’ve calculated that UNG should bottom at 10.4-11.0–it’s a lot harder to calculate this time, since its price disconnected from my $Natgas chart–as far as going higher this winter–that’s what everybody who is anybody is saying–so far!
Anybody here use Disqus comment tools? Increased my website traffic 500% in 6 months—
The NG ETFs are a huge part of the NG markets. For a description of why this is a problem, see http://ftalphaville.ft.com/blog/2009/06/11/56933/the-problem-with-commodity-etfs/
The ETF would hold 78% of the open positions in NG on NYMEX. 78%!
If you want NG exposure, buy a royalty trust. They don’t have expense ratios, are liquid, and pay a dividend if the price of NG goes up and if it goes down.
There are alot of games in the NG market, and alot of smart operators fleecing people who are only looking at the oil/gas price ratio.