Thirteen-dollar natural gas this winter?

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Thirteen-dollar nat gas? TheStreet,com -------------------------------------------------------------------------------- Natural Gas May Give You Heartburn By Christopher Edmonds Special to TheStreet.com Originally posted at 9:01 AM ET 10/27/00 on RealMoney.com

Thirteen-dollar gas? Natural gas, that is.

Some say it's possible -- and soon. Phillip Pace and his colleagues at Credit Suisse First Boston suggest the winter months may spur significantly higher natural gas prices. "We do not believe that much of the winter gas demand is elastic in the short term," Pace wrote in a recent note to clients. "[W]ith no plentiful, cheap supply of heating oil available, gas can ascend to whatever heights the market chooses. We doubt this is only 10 or 20% above current prices."

Pace's argument is a compelling example of too much demand and too little supply. He argues that natural gas demand can increase by 100% in the winter heating months. His math deserves thought: The average winter month pushes natural gas demand to around 80 billion cubic feet per day with demand reaching a peak of nearly 100 billion cubic feet per day. However, total supply, including imports, comes to only 60 billion cubic feet per day. Hence, even in a normal winter, sellers have increased pricing power. "As a result," Pace wrote, "The marginal buyer without adequate storage sets the price in the winter."

And this won't be a normal winter. From a supply standpoint, the season will begin with very low natural gas inventories. Even with Thursday's report from the American Gas Association that gas inventories rose 71 billion cubic feet, storage is still 12% below last year's levels. And, as of last week, the storage was at 77.8% of full capacity compared to a five-year average of 89%, with all regions well short of historic levels.

Additionally, unlike the previous two years of very mild winters, long-range forecasts from the National Oceanic and Atmospheric Administration suggest a colder than normal winter, including more subzero days in the central part of the nation, and colder weather along the Eastern Seaboard. Both regions rely heavily on fuel oil and natural gas for heat. And, the subzero days are troubling for supply, as the frigid arctic air is what drives gas usage to the 100 billion cubic feet per day peak levels. "If a predicted colder than normal winter follows the recent cool weather, we could see gas prices easily rising above the current rich levels," said Mark Easterbrook, natural gas and power analyst at Dain Rauscher Wessels in Dallas.

But is $13 gas realistic? After all, the recent highs in natural gas prices have only touched $5.50, and prices have slipped well below $5 this week. Pace says yes, and uses recent electricity markets to justify the claim. Since wholesale power was deregulated and power trading became widespread in 1998, peak summer demand has driven electricity prices through the roof. "Electricity prices spike by 50 to 100 times when demand gets peaky and prices in California are two to four times as high as in previous years," he wrote. "The impact of the weather in the winter is a more constant increase in demand for natural gas than what electricity experiences in the summer."

Pace says that creates the potential for price spikes -- two to three times the current natural gas prices -- in the coming months, and he believes they could last significantly longer than the temporary surges in power prices. "Importantly, we believe a $13 price could persist for a month or so, not just a few hours or a day. Most gas is sold during bid-week, just before the next month begins. Conditions during these days moving into December and January will be critical to prices."

What do those in the trenches think of Pace's prediction? It's possible under the right circumstances. "Could we see $13 gas for a short period of time under the right circumstances?" one natural gas trader asks. "It's a little stretch, but with the right temperatures and tight supply, it is possible."

Regardless of the exact numbers, this winter will see tight supply and higher prices. Investors looking to profit from inflated prices can either focus on the companies that produce gas, figuring higher prices lead to higher profits, or focus on companies that trade and market natural gas, and hope increased price volatility will lead to trading profits.

On the production side, Easterbrook and his colleagues at Dain Rauscher suggests looking at large-cap companies like Louis Dreyfus Natural Gas (LD:NYSE - news), Barrett Resources (BRR:NYSE - news), EOG Resources (EOG:NYSE - news) and Newfield Exploration (NFX:NYSE - news). He rates Louis Dreyfus as a strong buy and the others as a buy. Dain Rauscher has provided banking services to both Louis Dreyfus and EOG Resources in the past three years.

If you are looking for small-caps, he suggests looking at the Houston Exploration Company (THX:NYSE - news) and Chieftain International (CID:NYSE - news). He rates both as strong buys, and his firm has recently provided banking services for Chieftain.

From a trading perspective, the leader in the market is Enron (ENE:NYSE - news) which moves twice as much gas through its trading operation than its closest competitor. However, trading at nearly 50 times its 2001 earnings estimates, some analysts suggest it is fully valued. And, with its entrance into broadband and other commodities markets, it is no longer a pure energy play.

Other companies with leading positions in natural gas trading include Duke Energy (DUK:NYSE - news), Dynegy (DYN:NYSE - news), Utilicorp's (UCU:NYSE - news) Aquila Energy division and El Paso Energy (EPG:NYSE - news). Easterbrook rates Enron a strong buy and both Dynegy and El Paso a buy. His firm has not provided banking services to any.

While all of these companies stand to benefit from short-term surges in gas prices, CS First Boston's Pace doesn't see price extremes as a long-term positive for natural gas companies. "If it helps the stocks, it will be like borrowing from tomorrow to pay today," he wrote. "Such a spike should probably be viewed as an event to sell into unless the stock completely decouple from the commodity, as they do on occasion."

For now, however, as the weather sends a chill up your spine, natural gas stocks may well add warmth to your portfolio.

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Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to Chris Edmonds .

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-- Carl Jenkins (Somewherepress@aol.com), October 31, 2000


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