Lowly NatGas: Only For Bold Investors

February 29, 2016

On the one end of the spectrum, you have companies such as Southwestern Energy, whose shaky balance sheet have forced it to cut capital expenditures drastically. In fact, Southwestern says it's not currently drilling any new wells at all, but rather "managing [its] existing drilled but uncompleted well inventory."

Southwestern forecasts its output will drop 15% year-over-year under this strategy.

On the other end of the spectrum, there is Range Resources and Cabot Oil & Gas. With their relatively healthy balance sheets and higher-quality reserves, they are both forecasting growth in their production this year, despite lower capital expenditures.

Range sees growth of 8-10% for 2016, while Cabot sees growth of 2-7%.

Given these mixed signals and a history of upside surprises, it would be foolhardy to forecast with any conviction a decline in overall natural gas production for the U.S. At this point, inventors will need to see it to believe it.

Demand Slowly Rising

The outlook for U.S. natural gas production will be the key determinant of whether prices will remain depressed or whether they can stage a comeback down the line. But other factors such as demand and exports will play a significant role as well, longer term.

Natural gas will continue to gain share at the expense of coal when it comes to electricity generation, but not at the torrid pace of last year.

Power-sector demand was up nearly 20% in the first 11 months of 2015. However, much of that gain can be attributed to opportunistic coal-to-gas switching by utilities that can quickly move between the two fuels based on short-term economics.

Meanwhile, demand from industrial users declined slightly last year despite lower prices, a reflection of the struggling manufacturing sector in the U.S.

First LNG Exports

If demand alone is not enough to move the needle for natural gas and boost prices, perhaps exports will do the trick. Earlier this week, Cheniere Energy loaded its first cargo of liquefied natural gas at its Sabine Pass terminal in Louisiana, the first LNG export facility in the country.

This marks the start of a new era in which the U.S. becomes a major exporter of natural gas to the rest of the world, which will go a ways toward moving some of the country's abundant supplies elsewhere. This will effectively tighten the domestic market, potentially giving a lift to prices at some point.

In the near term, Cheniere only has the capacity to ship 0.65 bcf/d, but analysts expect LNG exports to grow to upward of 8 bcf/d by the end of the decade―equal to about 10% of current U.S. output.

Risky Sector To Invest

Even in the face of 16-year lows, it's hard to get excited about buying natural gas. The near-term fundamentals are horrible, and supply has remained stubbornly high despite promises of declines from analysts and producers.

On the positive side, demand and exports are moving in the right direction. If they succeed in absorbing the glut of supply that currently exists, perhaps prices can rebound to higher levels.

A diversified basket of exploration and production stocks, such as the First Trust ISE-Revere Natural Gas ETF (FCG | B-95) is a high-risk/high-reward way to get exposure to the space without having to deal with issues of contango that affect the United States Natural Gas Fund (UNG).

However, this ETF is not for the faint of heart. It's already down 23% this year on top of its 49% loss in 2015. Only the boldest of investors should wade into the natural gas pool.

FCG Price Chart

Contact Sumit Roy at [email protected].

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