Lowly NatGas: Only For Bold Investors

February 29, 2016

As poorly as oil prices have fared this year, it's nothing compared to another energy commodity. Prices for natural gas―a fuel that is used primary for heating and cooling needs―are down 25% so far in 2016, far outpacing the 10% decline in crude.

By the same token, the United States Natural Gas Fund (UNG | B-94) is down 28% compared with 19% for the United States Oil Fund (USO | B-100).

The downturn in natural gas has only added to the woes of an energy industry reeling from the worst oil bust in decades. Unfortunately, just as is the case for oil, it is unlikely there will be any quick turnaround for prices.

Too Much Supply

At the heart of the problem for natural gas is supply. Output continues to hit record highs, confounding most analysts who have been calling for a decline. It wasn't supposed to be profitable to drill for natural gas at such low prices, said the analysts. But clearly, they underestimated the economics of the business.

Technological advances, which have reduced the breakeven price of drilling for natural gas in shale, are largely responsible for the supply glut and price decline. But there's also an element of unbridled enthusiasm on the part of natural gas producers, who, up until a year and a half ago, were rewarded by the stock market for increasing production at any cost.

Shut out of the debt markets and with their share prices in tatters, producers are finally starting to cut back, but it's not showing up in the numbers yet.

Just this month, output hit a record of nearly 83 billion cubic feet per day, according to PointLogic Energy.

US Lower-48 NatGas Production

To make matters worse, this winter has been one of the mildest on record, which significantly reduced demand. Inventories―which typically bottom out in March―are bloated, with 615 billion cubic feet more natural gas in storage than last year.

Production Outlook Uncertain

To be sure, current natural gas prices reflect the abysmal fundamentals of the market. Earlier this week, natural gas hit $1.68/mmbtu, the lowest level in 16 years on a nominal basis, and the lowest level on record when adjusted for inflation.

Natural Gas Price Chart

The question now is whether these prices will finally spur the supply and demand adjustments that many are hoping for.

It certainly looks like the drilling binge is finally coming to an end—but is it really?

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