Cold Shoulder: As gas soars, pros counsel caution
Cheryl Strauss Einhorn
DECEMBER 11, 2000
Cold weather blew through the natural-gas pits last week, heating up fears that frigid temperatures might empty already low inventories. Not only did traders push prices to their highest levels ever -- near $10 per million British thermal units -- but the New York Mercantile Exchange, where the energy contracts change hands, halted trading repeatedly to guard against price spikes. It was the first time the exchange had done this.
On Wednesday morning alone, prices soared 19%. They're now up over 80% since the beginning of November and four times their level a year ago. Natural gas ended Friday at $8.58 per MMBtu, up around 30% on the week.
But the market isn't necessarily overheated. Some analysts say $10 is perfectly reasonable, given the circumstances. In fact, Goldman Sachs' energy research team suggests that the average price during the "winter-strip" (November to March) will be $7.16 per MMBtu. Reason: Stocks are 17% below year-earlier levels and recent data show the gap widening.
Natural gas -- like oil -- has enjoyed a steady increase in popularity that has been masked by unusually mild weather in much of the U.S. over the past three years.
Thus, prices have been low. In fact, they bottomed at $1.62 per MMBtu in February 1999. Even as late as January of this year, the price was just $2.17.
Given the sustained lackluster demand, companies shuttered capacity and stopped looking for new supplies. Production dropped 7%. All the while, however, industrial demand has been growing, fanned by the lengthy economic boom. And a million new homes were built in each of the past few years -- most with natural-gas heating systems.
Now, with cold weather upon us -- just last week temperatures were more than 40% below normal for this time of year in the major Eastern gas-consuming region -- there's not only a resurgence in demand from consumers firing up those heating systems, but from industrial users, too. Industry now accounts for 45% of total gas usage.
The weight of all this was felt acutely last week in places like California and New York, where wholesale prices for gas soared past $20 per MMBtu, 10 times year-ago levels.
Still, we haven't rationed much demand. Given the rate at which we're drawing down supplies, the market is on pace to trim inventories to below 600 billion cubic feet, according to Goldman Sachs. That would be the lowest level ever recorded and well below the last low of 700 BCF -- a figure considered the nation's minimum operating level -- reached in 1996.
Usually stocks range between 1,000 and 1,400 BCF at winter's end. And while gas companies have begun drilling again reaching their highest level in a decade with over 800 rigs in operation at the onset of November -- analysts don't expect any real gains in supplies until next year. Even then, production is expected to rise only 3.5% or so, not enough to meet demand. In fact, such an increase would only bring new supplies back to 1997 levels.
Yet despite the clearly bullish outlook for prices, professional traders we talked with are wary. They caution against jumping into the futures market now; more volatility is ahead, and no one knows exactly what the weather will do. If we get a warm spell, the market could sell off to $5. Still, while futures may be too risky now, equity analysts say there are opportunities in natural-gas shares.
Both Tom Driscoll at Lehman Brothers and Bill Featherston at PaineWebber like Devon Energy and Apache. In part, they say, gas stocks haven't fared well lately because of fears that oil prices will moderate at the beginning of 2001. Because oil is the "captain of the energy market," as Featherston puts it, exploration and production stocks haven't really moved as gas prices have soared. "The index of our gas stocks was 57 in August, when gas prices were $4.50, and it is at 57 now," says Featherston.
At current levels, the stocks, he says, are discounting $2.50 gas. "They don't have to discount $5 gas for next year, they can discount $3.25, which is the price at which these producers earn their cost of capital, and that implies a 35% upside from current levels."
In truth, the market can be even more optimistic. The outlook for gas is much sunnier than $3.25 per MMBtu. It has to be, simply to stimulate new supplies.
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Above from Commodities Corner in Saturday's Barrons. |
