Are We Having a Natural Gas Crisis?
by Bill Powers, Editor
Canadian Energy Viewpoint
August 1, 2003
Natural Gas Market Update
There appears to be a great deal of confusion as to the true state of the North American natural gas market. Washington politicians, who are often long on rhetoric and short on results, tell us we are facing a natural gas crisis. NYMEX futures traders seem to think the potential for a crisis is dissipating after several weeks of strong storage injection numbers. I believe we are in the early stages of a natural gas crisis and provide three fundamental reasons to support this claim. (Please note, in below tables I have used the most recent data available.)
1) Falling natural gas production in the US and Canada.
One of the oldest and best collectors of petroleum data in the United States is the Texas Railroad Commission (RRC). After the massive East Texas field was discovered in 1930, the country was awash in oil. The East Texas discovery drove the price of oil from $1.10 a barrel to only $.10 a barrel. In 1932, the Texas legislature, in an effort to support the price of oil, passed a law giving the RRC control over oil production. (It should be noted that OPEC used the RRC as a blueprint for its foundation). If a well operator went over his quota, the RRC sent out the Texas Rangers to put a stop to the cheating.
Today, the Texas RRC monitors both oil and natural gas production. With Texas producing over 30% of all natural gas in the United States, the monthly natural gas production numbers issued by the Texas RRC are a proxy for US production.
Natural gas production from the state of Texas has been in a steady state of decline for the past 12 months.
Texas Natural Gas Production*
*Source: Texas Railroad Commission
After only a 1% increase in natural gas production in 2002, Canada is on track to experience its first production decline is several decades. According Natural Resources Canada, March 2003 production totaled 529 billion cubic feet (bcf), down 3% from March 2002 levels. I expect several more months of year-over-year production declines (between 3-5%) as Canadian producers struggle to replace falling production out of Ladyfern and elsewhere.
As I was putting the finishing touches on this month’s newsletter, the Alberta Energy and Utilities Board handed down its final decision to shutter 900 natural gas wells in northern Alberta to protect the bitumen surrounding the reservoirs. Bitumen is the raw material used to make synthetic crude oil. The shutdown, which will take effect on August 1st, will affect wells which account for 2% of Alberta’s total natural gas production.
2) North American natural gas consumption continues to rise.
North America’s decline in natural gas production is coming at a time of growing consumption. The below table clearly illustrates Canada’s healthy natural gas consumption growth over the past year. Future years are certain to bring even higher consumption levels as several synthetic crude projects in northern Alberta come online.
US natural gas consumption continues to remain strong despite a sluggish economy. While makers of fertilizers and chemicals continue to head for countries with cheaper natural gas, there still remain two growth areas for natural gas consumption. The proliferation of McMansions, thanks to the easy money of Alan Greenspan, that dot the landscape of suburban America, are certain to keep a floor under US natural gas consumption. Over 70% of all new homes built in the past five years use natural gas as their primary heating source. Very few homeowners will let their biggest asset go to ruin no matter how high natural gas prices go in the next few winters.
The other big driver of US natural gas consumption will be as feedstock for natural gas fired power plants. While the pace of new gas fired power plant construction has slowed in recent months, there is a strong possibility that gas fired power plant construction will continue for the foreseeable future. As discussed in the June 2003 issue (see Boric Acid and Natural Gas), the aging nuclear power plant fleet in the US is a sleeping giant for natural gas consumption. While there are only a handful of nuclear facilities that are up for re-certification in the next few years, the end of this decade is a different story. In the years 2009 to 2011, nearly 25% of the nuclear power producing facilities in the US will be up for re-certification. While it is unclear how many of today’s active reactors will be de-commissioned, any reduction in US nuclear generating capability will likely be replaced by natural gas fired power plants.
3) North American natural gas storage levels remain below historical norms.
While many market observers have become concerned about the fall out from 2 months of high natural gas storage injection numbers in the US, I believe the US natural gas storage picture remains very bullish. The key to understanding the natural gas market is to look at the supply picture. As previously mentioned, production continues to fall in both the US and Canada. The quote below is from the US Energy Information Agency’s storage report for the week ending July 4, 2003:
“Working gas in storage was 1,773 Bcf as of Friday, July 04, 2003, according to EIA estimates. This represents a net increase of 111 Bcf from the previous week. Stocks were 580 Bcf less than last year at this time and 317 Bcf below the 5-year average of 2,090 Bcf…..At 1,773 Bcf, total working gas is below the 5-year historical range.”
While the year-over-year supply deficit has come down in recent weeks, I believe the reasons for the deficit reductions are temporary in nature. Very mild early summer weather and fuel switching to distillates have accounted for a significant portion of the recent high injection numbers in the US. With the arrival of more normal summer weather in the US and surging crude oil prices (making distillates less competitive), I have serious doubts we will continue to see above average storage injections much longer.
The natural gas storage picture in Canada is equally bullish. With Canadian storage 37% less than year ago levels (228 BCF vs. 361 BCF in 2002) Canada also has a significant storage deficit to make up before the start of the winter heating season. With the heating season starting a month earlier in Canada than in the US, we are nearly certain to see a significant curtailment of imports to the US in coming weeks.
Energy Apathy
Apathy towards an investment class is a sure sign tremendous returns await patient investors. In 1980, Dr. Marc Faber gave a speech about US government bonds at an investment conference in Hong Kong. Dr. Faber’s speech was scheduled for the afternoon session of the conference. The topic of the morning session was gold. Needless to say, the auditorium was standing room only for the morning discussion on gold. At a time of over 15% interest rates on US government bonds, Dr. Faber only had one person in the audience for his speech. Talk about apathy towards an investment class!! After thanking the one gentleman who attended, Dr. Faber immediately sold all of his gold and loaded up on long-term US bonds. Gold has still not returned to its highs of 1980 and all high quality bonds were a great investment and have outperformed equities. (Today the roles have reversed, gold is a tremendous investment class and US Treasuries should be avoided.)
I believe we are currently witnessing three distinct types of apathy towards energy: media, industry and investor apathy. This indifference, coupled with the sector’s strong fundamentals, has created one off the most bullish signals that energy is going to be an outstanding investment class for the next decade.
The amount of apathy towards energy as an investment class by the financial media is truly mind boggling. While recently perusing several widely read financial periodicals, it struck me as unfathomable that many do not contain even a mention of energy much less a story. Some of the worst offenders continue to have entire sections dedicated to technology investing; while completely ignoring the world’s largest industry, energy.
In an environment that is truly nirvana for North American E&P companies (high energy prices, low interest rates and very good rig availability), we have seen only a modest increase in activity. It appears that many E&P management teams are still not convinced that high energy prices are here to stay. This lack of conviction shows up in a stagnating number of rigs actively searching for oil and gas. We have seen the Baker Hughes US natural gas rig count hover around the 900 mark for the past 9 weeks. There are simply not enough rigs to stem the production decline of natural gas in the US.
The disinterest towards energy among the investment community is truly amazing considering that energy investments offer a risk/reward ratio that only comes along once in a generation. Just about every firm in the Model Portfolio is on track for record cash flow and earnings in 2003 and yet many of the stocks still trade at single digit price/earning multiples. With natural gas prices likely to hold the $5US range for the balance of the year and oil stubbornly remaining over $30US, I see little to derail record performance for all of 2003.
While the fundamentals of energy equities are extremely strong, I consider the recent stock market activity in the US the most bullish signal that energy shares will head significantly higher. The quote below can be found in Michael Santoli’s “The Trader” column in the June 14, 2003 issue of Barron’s:
“A ranking of S&P 500 stocks by their returns since the recent market low March 11 reveals a pattern among the lagging 80 stocks. The list is thick with energy and consumer staples companies, many with fairly bankable earnings and above-average dividend yields…”
The fact that the best performers of this bear market rally are the market’s most speculative issues clearly indicates that the general bear market in equities is not over. Until market participants become painfully disabused of the notion that purchasing the market’s riskiest, highest beta stocks is the way to compensate for previous portfolio losses, the outstanding fundamentals of the energy sector will continue to be ignored.
Bank of Canada Lowers Rates
On June 15th, the Bank of Canada lowered its key overnight lending rate 25 basis points to 3%. This caused the Loonie to give up previous gains against the US dollar. One US dollar now buys $1.39 of Canadian assets. The official statement the BOC gave as reasons for the rate cut ranged from mad cow disease to SARS but mostly focused on the appreciation of the US dollar against the Canadian dollar.
I have repeatedly stated in this newsletter my strong belief that the US and Canadian dollars are going to parity before the end of 2007. The recent rate cut by the BOC does no alter this belief. The US is likely to resume its descent against the Canadian dollar and other commodity currencies before too long due to the anemic state of the US economy. The ballooning US federal budget deficit, the growing federal debt and the large US current account deficit will make it hard for the US dollar to stay afloat much longer.
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See full article with exhibits at financialsense.com
The issue of whether there is or isn't an energy crisis is moot at this time IMO. Point is energy stocks are very undervalued given the facts we know now. |
