NATURAL GAS: THE FIVE STAGES TO MARKET PANIC
by Charles T. Maxwell, Senior Energy Analyst
maxwell@weedenco.com....................................The low natural gas reinjection numbers we have seen so far this spring in the US tell their own tale. We are not on our way
to putting three trillion cubic feet of gas, or anything like it, into storage for use next winter. From a low of one trillion cubic
feet (and nearly 50 % of that is facility and line "fill", i.e., is not usable), we would be fortunate now to bring stored supplies
up to 2.3 Tcf by early next November, the start of the gas consuming season. Given the presumed retreat of the La Ni¤a
weather pattern, the strong US economy, and the substantial number of new natural-gas-fueled base-load generating plants
using combined-cycle technology coming on stream over the next six months, I have had to revise my estimate for peak gas
storage down a bit from the 2.5 Tcf number I was using two months ago.
In practical terms, unless the coming winter approaches the highly-unusual, +13% warmer-than ?usual season we have just
passed through, US gas storage numbers are accumulating in a potentially disastrous pattern of insufficient gas to take this
country through the full span of cold weather to April of 2001. There is the possibility that we will be forced to allocate gas
supplies to private homes, government departments and public institutions, to defense installations and to schools, universities,
hospitals, and so on. To the degree that is necessary, gas will have to be allocated away from manufacturing industry. Hit
hardest, in such a period, would be sectors of the economy that use a high proportion of natural gas in their fuel mix such as
cement plants, glass works, heat-treating and metal-shaping plants, heavy chemicals, steel, copper and aluminum makers, and
so on. Subsequently, problems of insufficient production of component parts and intermediate materials could quickly spread
to car and aircraft manufacturers, commercial construction and machine assembly industries. In short, the use of natural gas is
so widespread in our manufacturing system that shortages of it for, say, a two month period from late January of 2001 to late
March would wreak havoc on many areas of our economy. It would surely slow national GDP growth, and heavily penalize
the profits of many industrial firms.
However, all this is theoretical. It really couldn?t turn out this way, could it? Yes, it could. And, unless the trends I see in
place now of close to 3 % incremental natural gas consumption in the US vs. flat or slightly down natural gas production are
reversed for some reason I cannot now perceive, the "disaster scenario" outlined above must be considered the most likely
one.
Perhaps the most intriguing part of the emerging outlook for a shortfall in gas supplies is not the fact that the crisis has arrived
(after all it has been predicted for years, and, up to now, nothing serious has occurred), but rather the point that we are
advancing deeper and deeper into this energy problem and no one, other than a few Wall Street analysts, are making any
warning noises about it. The media is quiet. It is either non-believing or unimpressed by the dimensions of what is visible.
Government, at all levels, is complacent. There are no public outcries even from executive figures in gas consuming industries
that are heavily dependent on the fuel. We are becalmed in a sea of silence on this issue as we pass into summer. The
weather is fair, and the "livin? is easy". And, when winter comes? It?s just another season, following summer. Nothing to
worry about.
However, a few important people in the system quite plainly see the outlines of what is to come. Their traders are bidding up
the price of natural gas dramatically (now 100% higher than the last year?s $2.10 per mm btu price at this season) in order to
secure supplies for storage now - supplies that may not be available next February when many industries could be facing
downtime. These gas buyers are doing their homework. And, it is their lead that investors should be following.
Still, I am ahead of the story in my surprise that the media has not yet picked up on the coming crisis. For over the years (and
I have a good many of them), it has been my experience that there is a repetitive cycle to how these "threats" to the system
are understood and acted on by different parts of our society.
In the case of the emerging shortage of natural gas, to take the example before us, the first group to identify it was the
industry specialists (apart from many natural gas production company managers who had spotted it years in advance), in
particular a small group of Wall Street analysts who were doing their weekly storage sums and saw that behind the fa‡ade of
last winter?s warmth was a highly worrisome picture of an industry failing to convert its greater effort to find supplies (some
650 rigs drilling for gas this year vs. some 380 drilling for gas last year at the same time) into rising output figures. Across the
board, analysts in the oil and gas industry are now convinced there is a substantial problem ahead. This is Stage One, and it is
nearly completed.
Stage Two is the tricky one. Analysts must convince their portfolio people that the problem is real, and direct them to what
areas of the market to buy and what to avoid to maximize investment returns. But, portfolio managers are resistant to these
arguments (they have heard them before). So, only a few comprehend and accept the fundamental story, then take action.
But, those brave souls start building upward momentum into the limited group of gas producing stocks that can be bought in
size by the institutions (APC-53, BR-45, UCL-38, APA-60, DVN-60, and EOG-32, in order of descending capitalization).
Then, that section of institutional portfolio managers which cannot yet grasp the play itself but which is attuned to moving into
stock groups with rising upward momentum in the market (for whatever reason), can be expected to swing onto the story. In
this case, the natural gas producing group has recently come up on everyone?s charts as being in the lift-off stage. Finally, the
remaining portfolio managers, still not convinced, are forced to act in order to maintain their performance rankings, and they
belatedly enter the game.
We are better than halfway through Stage Two now, as I make it out. The fundamental players are "in", and the momentum
players are starting to react. But, as to a general capitulation of portfolio managers to the natural gas shortage concept, that
will be reserved for quarter-ending rallies in June and September yet to come, if I am reading the tea leaves correctly.
As I have previously noted, the media have not yet focused on this problem. That will be Stage Three. There is a substantial
story to tell here. Outages in industrial plants across (mainly) the Midwest and Northeast, with tens of thousands of workers
staying home, is a major development. When TV reporters, newspapers and magazines eventually pick up the trend, perhaps
several months will have passed and the situation may well be seen as more grave. Having professionally worked through the
period of Energy Crisis I and II, it would not surprise me if the media termed the new "threat" as Energy Crisis III. However,
I don?t think that this natural gas problem will have the public impact of the first two crises. Lack of gasoline (read mobility)
and long waiting lines to obtain it may be more effective in influencing the American psyche than 100 industrial plants being
shut down. However, Energy Crisis III is a convenient name, and at least it has the advantage of catching people?s attention.
Stage Three is a big step in the development of a crisis mentality in the market for gas-related stocks. But, we are not yet into
this stage yet.
On the basis of widespread (future) media attention, Stage Four would involve governmental reaction to this, on all levels. By
late summer and early autumn, we will be into the late days of the Clinton Administration?s time in office. It certainly could be
a political problem to admit that something this important had been allowed to develop, unbeknown to all, into a significant
threat to the system. On the other hand, the issue cannot be easily swept under the carpet because its effects are too close to
breaking through into public consciousness. Moreover, the Gore-Bush pre-election debates should be in full swing by then,
and Bush would be well guided to raise points, such as this, in which he has had some practical experience and for which no
anticipatory consideration has been made in the non-existent national energy plan that President Clinton never formulated (nor
did any other previous US president). As I see it, the Government will be forced to confirm the size and scope of the gas
problem, and will further alarm industry by referring to the possibility of gas allocation on a national, state or local level.
Stage Four could well occur in September and October of this year. Its outcome would logically lead to Stage Five, the final
rush to panic and overexposure. This would be the result of heightened media attention, followed by effective governmental
confirmation that the problem was real and might not be easily fixed except through significant sacrifices on the part of the
public. Stage Five would represent a general recognition that we could be entering a difficult period of fuel shortages and that
the effects might be more serious than mere "inconvenience". It should be noted that under any allocation formula, those
organizations and industries that could switch from natural gas to propane, butane, heating oil or residual fuel oil would be
asked to do so. And, subsequently, these products might themselves run short under the impact of unexpectedly high
demand. They might also advance dramatically in price. Stage Five would also imply a highly visible case for investing in
companies that might be best positioned to assist in solving the natural gas shortage. The final run of small investors? funds
into the natural gas producers might represent a "tsunami" of money seeking entry to a play already suffering from limited
capitalization, thus forcing gas producer share prices into the "blue yonder".
Stage Five, perhaps occurring in mid-to-late autumn, would, of course, be immediately followed by the actual onset of cold
weather. By then, investors would also have full knowledge of the country?s three-quarter-filled gas storage position. Early
outages might start to occur, for coincidental reasons, in late January of 2001. However, the main weight of the shortfall
would be expected to fall when different major storage points in various consuming regions of the country ran out of supplies
in February and March of next year. That is when companies, facing closedowns for lack of fuel, should be most pressured
to bid for gas to avoid the termination of output and temporary disbandment of their labor forces. So, we have assumed a
peak to natural gas prices in February of 2001, probably in the $6.00 ? 7.00 per mm btu range following a prolonged period
of cold weather. This could be the high point of fear, when many businesses could be driven to uneconomic decisions just to
survive.This would logically be the exit point for experienced investors. With all five stages of the play completed, and the axe
of cold weather fallen, this would be the time to collect your chips and leave the game. Conditions will likely not be so
desperate or so uncertain again for some time, experience teaches us. Of course, the natural gas problem itself will not
suddenly go away. It will take many seasons to find an answer to it. But, we will solve the problem, as we always do. And,
as we move through the crisis and consider our options, all kinds of answers will present themselves. Meanwhile, the stock
prices of natural gas producers would be expected to start down as early desperation gave way to later resolution.
What will be the eventual answers to the natural gas shortfall? Think about a higher range of prices, application of additional
technology, new generations of sophisticated drilling rigs, more LNG receiving terminals, and what can come south from
Alaska. |
