Have Natural Gas Prices Hit Bottom?

It's been a summer of open windows and dormant air conditioners in the Eastern U.S. as the mercury has failed to break 85 degrees on most days and night-time lows fall down to the mid-50s in much of New England.

And that partially explains why natural gas prices are plunging to seven-month lows. Gas-fueled power plants are operating at a low hum as electricity demand has been unusually tepid. When you consider that late July typically represents a turning point for summer temperatures, this may turn out to be a year without any major heat waves. Good news indeed for residents in the Eastern U.S. after enduring an unusually dispiriting frigid winter.

As demand for gas remains subpar, gas storage facilities are re-filling at a rapid rate, turning gas back into a buyer's market. That's a quick change from six months ago when gas was being consumed at a faster-than-normal rate. And the resulting price collapse has left many to wonder: Will gas prices keep plunging, or have they hit bottom?

The answer to that question: Gas prices are likely to keep falling.

Tepid demand is likely to lead to more increases in the amount of gas in storage, and with each weekly update from the Energy Information Administration (EIA), gas prices will likely move down another leg. A commodity needs a catalyst to reverse direction, and natural gas prices have no positive l catalysts on the near-term horizon. Also, recall that gas prices were historically closer to $3 per thousand cubic feet (MCF) before last winter's polar vortex, so there's no reason to think that the current $4 per MCF price range represents any sort of bottom.

But the continued erosion in gas prices means that you should now be monitoring this commodity. Because when a bottom is in, there could be a solid snapback in prices. That's because the supply side of the equation continues to be a question mark for some investors. Though exploration for oil and gas in the nation's shale regions remains robust, geologists will tell you that such deposits are at their production peak in the first few years of drilling before a steady rate of depletion takes place. And many productive gas wells have already been gushing output for several years now. Looked at another way, the most promising shale segments have already been staked and newer areas of gas development hold lesser output potential than the first wave.

As it stands, falling gas prices are likely to deter gas producers from tapping more wells. According to Baker Hughes, the number of rigs dedicated solely to gas production in North America has fallen from 369 a year ago to a recent 311. That's down from 1,500 in 2008 and represents the lowest figure since 1993. To be sure, today's wells are more productive, but the laws of depletion argue against maintaining their pace of prodigious output. Thus far in the shale gas revolution, we have yet to see a sharp drop in depletion rates. But as news of depletion rates starts to trickle in, sentiment toward this issue could shift quickly.

Pivoting back to the other end of the equation, when will demand rebound for natural gas? We'll find out as we approach the coming winter season. One of my favorite indicators is the Siberian ice pack. Last autumn, this indicator again showed an uncanny ability to predict temperature patterns in North America over the ensuing winter. If you are looking at natural gas as a commodity investment, or natural-gas related stocks, then I encourage you to repeatedly monitor this website beginning in early October.

Taken together, both the supply and demand side of the equation portend a further drop in gas prices. So avoid the temptation to start bottom fishing. As an example, several analysts gave recently sung the praises of Rice Energy (NYSE: RICE), a fast-growing gas producer. "Rice's Marcellus well designs achieve the best reservoir drainage of the group currently," note analysts at Cannacord Genuity, who see shares doubling to $51. But as this company's stock price chart shows, investors are paying more attention to gas prices right now than company-specific outlooks.

Risks to Consider: If you directly invest in natural gas producers, you need to keep an eye on their balance sheets. Some of these firms are counting on firm natural gas prices to support their capital spending programs and debt burdens and falling gas prices may imperil their cash flow.

Action to Take -- The outlook for a further drop in gas prices suggest you should start gathering a watch list of favorite gas names. Some of them like Rice Energy are steadily sinking. But when a floor is in, such stocks will represent solid upside potential again. And as I noted in my follow-up look at the polar vortex theme key commodity-specific exchange-traded funds (ETFs) represent better leverage to prices than the underlying gas producers.

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