Wednesday, August 12, 2015

Natural Gas During the Slump

Crude oil prices posted modest gains as a quiet market responded to strong demand data from international reports. After an injurious reaction to the devaluation of the yuan, WTI prices opened just above $43.00 and struggle to maintain any gains as the day continues. Demand reports came from significant consumption increases due to extremely low spot prices. Also today. natural gas prices rose as modestly as its crude counterpart did. This can probably be attributed to positive demand statistics as well. With gains in both categories, both industries experienced positive movements today with the oil and gas index (XOI) gaining 1.2% and the natural gas index (XNG) adding 1.5%. For both indexes, there were 18 winners and 2 losers on the day, a strikingly similar comparison.



The charts above are excerpts of the oil industry index and the natural gas index, and if I never made that distinction, one might never tell the difference between these charts. It is clear from the patterns above that there is a significant connection among the well-being of the companies that operates in each respective industry. At first, I questioned how relevant the similarity could be as many oil services have investment in the natural gas, but upon further research, I found that the indexes don't have a single company that is a member of the other. While that may be the case, many of the natural gas companies listed rely on both commodities in operations (Cabot Oil & Gas Corporation, Ultra Petroleum, etc.). The charts of XNG and XOI show decreases over May and June due to poor revenues and supply and demand data that damaged the crude oil prices. They also show the sharp decline in early July when earnings week tore apart oil and gas companies that lost substantial revenue and profit taking to low prices. Thus, a connection between the two commodities prices can be found through the companies that dominates the sectors. Natural gas will always be associated with crude oil because the only companies that could efficiently stake a claim to it were those with capital and energy knowledge with which to invest. If an energy firm that produces both natural gas and crude oil must deal with low WTI price, (as we've seen) revenue and investment spending will drop souring prospects for advancements in oil and natural gas technologies. Likewise, high demand and low supply that cause inflation in the crude oil price could result in similar pressures in the natural gas sector. The Baker Institute of Rice University furthers the connection with their research on the two commodities. They find that price trends of crude oil and natural gas react to each other through the pricing of a refined product, residual fuel oil. Crude oil is an input for this heavy oil which is used for electricity generation and other industry which is where a majority of natural gas capacity is consumed. So in a price slump where refined products used for electricity generation are cheap because of crude oil, demand for natural gas will decrease as will the commodity price. What does this mean for investors? In the new era of basement oil prices, a supply glut will keep depressive forces over natural gas due to fundamentals in the energy sector. Deflated prices will hurt integrated energy services that want to expand but won't have the capital. Diversification is the important thing as firms look at their asset portfolio in the future. Prices are low now, but overall demand is increasing as well natural gas's share of that demand. As a long term trader, I would look favorably upon an upward trend for natural gas and energy companies with considerable investments in that commodity. Demand data shows a rapidly increasing general energy consumption with natural gas outpacing coal as a key electricity producer. As a short term trader, I would suggest finding solid energy stocks with diversified portfolios. Having both natural gas and crude oil stockpiles will preserve a position in a market that is heavily slanted against crude oil. Diversification will be important in the worst case scenario at long-term oil prices and the best case where windfall profit-taking will allow for expansion into a commodity that is finding its foothold in the energy sector.

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