Subscribe to Money Morning get daily headlines subscribe now! Money Morning Private Briefing today's private briefing Access Your Profit Alerts

2012 Natural Gas Price Forecast: Why to Avoid the "Widow Maker"

I've been watching natural gas for years now and find myself shaking my head lately.

The cost to buy the "clean energy" is collapsing as crude oil, a product that needs refining, stays above $100 per barrel.

In fact, this chart for natural gas is what I call a Widow Maker.

Take a look:

As you can see, it shows the price of the March 2012 NG contract over the past two years – and it's not pretty.

Why Natural Gas Prices Will Continue to Drop

The last time I wrote about natural gas for Buy, Sell or Hold was November 2010.

At the time, natural gas was about to start its most seasonally bullish period of the year. I recommended a multi-month trade with an exit by the end of the March 2011 contract.

However, this year is completely different. Natural gas has collapsed in price instead of climbing during the peak winter cold months.

While it's been a warmer than normal winter across the United States, especially in the Snow Belt, this price drop has more to do with U.S. production rising on a year-over-year basis than it does the weather.

Ordinarily, the ratio of gas to oil on a BTU basis is 6:1. Today, with natural gas selling for $2.65 or so and crude over $100, though, the same ratio is currently 37:1 – not even close to the historical benchmark.

The next chart explains why natural gas pricing is going down and will stay down longer than most people expect.

Currently, the number of natural gas rigs is still climbing in the Eagle Ford area, while remaining level in the Bakken and Marcellus shale formations.

Why this matters is simple: These rig counts will have an impact on U.S. natural gas prices far into the future.

Here's why.

Eagle Ford shale wells, while called "gas," have a "wet sweet" production profile. In other words, they also produce natural gas liquids.

These liquids are super sweet (that is, they are very low in sulfur) and make a great blending stock with heavy sour oil, allowing producers to take two products derived at sub-spot crude oil prices and blend them into a West Texas Intermediate (WTI) equivalent.

Again, these wells are being drilled for their crude oil-like liquids rather than their gas, at close to $100 a barrel for crude versus about $2.65 for natural gas.

The kicker? They typically have to produce the gas anyway to lift the liquids out.

As a result, the natural gas market stays saturated with new incremental supplies, which works to keep natural gas prices low.

I expect this trend to continue into 2012, making higher natural gas prices unlikely.

Oversupply: A Glut of Natural Gas

A bit of history shows us why…

Before the buildout of natural gas combined-cycle power plants in the 1990s, the United States had a yearly glut in gas. Producers actually shut down their production wells for months at a time.

What's more, there was no takeoff capacity to produce more gas, since the pipelines were full and the storage facilities were maxed out.

Today, we have returned to a similar environment.

In fact, the United States has a large selection of individual natural gas basins and prices are rarely the same in each, due to pipeline takeoff capacity and other similar factors.

As a result, we could see individual basins with a short-term price of $0.00 per Mcf (1,000 cubic feet) this summer. That's no typo. The cost of natural gas in certain places could go to zero.

Further, I expect to see un-hedged natural gas producers go bankrupt this fall, since the cost to carry production on leased lands exceeds the value of the cash flows from the fields.

You see, natural gas will be worthless to its producers for a period of days or weeks at a time.

This will impact the top and bottom lines of companies that have to produce, let alone sell, into that environment.

There may even be localized negative rates created when a company has to produce from lease properties or return the ownership to the mineral rights holders.

It is a case where companies put millions into drilling wells on a ranch and then can't sell their product because there is no market for it.

The Long Term Outlook for Natural Gas

I don't expect to see a clear trend change in natural gas prices until 2013 or later depending upon the buildout of U.S. liquid natural gas export capacity.

The U.S. government has received a growing list of requests from LNG import facilities, to allow them to be converted into LNG export facilities. These conversion projects will start to come online in 2015. So far there have been plans submitted to export the equivalent of 17% of the United States' daily natural gas production, but for now that production has to sell within the United States – or not.

If all of these facilities are built, the United States could be the world's largest liquid natural gas exporter by 2020. Just a few years ago the United States was projected to be the largest consumer of liquid natural gas by 2020.

Needless to say, the swing from one extreme to the other has been staggering.

In the meantime, smart investors will stay out of the way of the Widow Maker. Expect natural gas prices to stay low for 2012 and beyond.

It is also time to start considering the impacts that a natural gas glut will have on the companies providing drilling supplies to the exploration and production (E&P) companies.

Some high-flying stocks in the O&G service sector will be negatively impacted when the rush to drill and frack a shale well is over. The golden days of the shale rush are just about over and with that, a return to gravity for some of these high-flying stocks.

In my next Buy, Sell or Hold piece, I will be looking at one of those high-flying stocks, which is facing a moratorium on its business model.

The implications are bigger than the market realizes.

News and Related Story Links:

Join the conversation. Click here to jump to comments…

  1. Werner | January 16, 2012

    Thank you for your analysis, Jack. Shall keep my fingers off NG related stocks alltogether!

  2. Jesse | January 16, 2012

    Great analysis! What natural gas stocks in your opinion are in the worst shape?

  3. Observer | January 16, 2012

    I want to know how to convert my F-150 to Nat -Gas. Paying $60 per tankful is crazy.

    • acrossthepond | January 17, 2012

      Never mind natural gas,once you get it converted you can guarantee evryone else will have done the same and subsequently drive the prices to a paralell with petrol (gasoline)Happened in Australia 2005-2007. 55C/L – >$1 within two years. Anyway driving a machine which does 14MPG unladen is seriously inefficient. Maybe consider changing to a diesel,around 60% more MPG.
      Just spare a thought for us europeans paying E7.15 for a gallen of petrol. Oil is becoming very unfashionable for lots of reasons. Economically, environmentally and it's proceeds going to numerous countries with anti American sentiment. These are only a few reasons.
      Am looking forward to break throughs in battery technology for electric driven vehicles. German engineers are looking promising.

    • dayneyus | January 22, 2012

      NG conversion will cost you $10,000 to $15,000. That's way we need Gov subsidy and change in regulations to bring more players into manufacturing conversion equipment.

    • TONY | February 13, 2012

      THats a great way to use up clean energy mAKE AND USE ELECTRIC FROM GAS AS WELL

  4. Cliff Williams | January 16, 2012

    Rarely do I see analysis on the oil and gas markets which correctly reflects the state of the industry. You know natural gas and you know the particulars of the drilling side and as an oil and gas attorney saturated in both transactional and title opinion work I find your information true.

    The one opportunity I see is that when the natural gas market is down it is possible for a company or individual (in my case) to make an advantageous buy for an individual well or field of natural gas wells situating themselves for the inevitable rise in natural gas prices. Timing those buys then is the question.

  5. medicman | January 16, 2012

    Westport Innovations is the stock to buy for the technology. Not sure where to get the actual kits but UPS and ARK OKLA Gas both have vehicles that are converted and they should be able to tell you where the kits were obtatined.

  6. medicman | January 16, 2012

    Cost for fuel is approximately 2.00/ gal of cng equivalent to current $3.25 gasoline. Compressed natural gas stations are being opened here in OK/ARK. Ft Smith AR, Tulsa, OKC all have stations open now.

  7. PetroleumEngineer | January 16, 2012

    The market is called foreign LNG. We'll have export terminals up in no time where the gas will sell for $12-15/mcf to countries like Japan.

  8. rural development specialist | January 17, 2012

    Great analysis, thanks.

    Anyone who thinks that pursuing becoming a fracked natural gas exporter is any good for the US as a whole– although possibly good for a particular investor– has visited neither a shale gas field nor an O&G exporting nation. I'm with the author– it is time to reallocate capital away from the O&G service companies and toward renewables.

  9. Lee Major | January 29, 2012

    I agree that our NG checks from the ranch have truly been reduced is it not the future for LNG to come on line and start shipping at pricing of $14.00 – $18.00 a mcf.There many countries pay out at this level today.Talk about extra jobs.
    We are in the Eagle Ford and there is tons of NG being producted as well as oil.

    Excellent information on your part……

  10. Doc A | January 30, 2012

    This article is accurate from an economic macro Investment standpoint, however while most of the larger O & G players are weighted in oil and gas. Most companies will redirect activities to oil basins which will utilize the drilling and well service sector equipment. Take haynsEville gas shale most of those rigs are moving to eagle ford bakken and granite wash in west Tx I agree that the highly leveraged negative EPS companies weighted in NG could have real issues
    Zero $ NG could happen in the coal bed areas because BTU factor is marginal as with most methane gas So far we have not seen a decline in Oil and Gas equipment

  11. Erwin cajamarca | March 26, 2012

    Everyone is bearish Nat Gas.. Ill take the contrarian side… everyone was bearish bank stocks in Nov. Now they love them.. Nat Gas will be no different. time to buy is now that everyone hates them. I see the turn in nat gas next quarter.

  12. Steve | March 31, 2012

    I retire in 30 years. Buy a triple nat gas etf for $1 and wait?

  13. sanford wallerstein | April 10, 2012

    Hi Jack,
    Unfortunately I just read today your Natural Gas Forecast written in January 2012. I own a 'basket' of the 'top' MLPs which have all suffered YTD. At this point do you believe it is a sector one should exit for the foreseeable future. Being mostly pipeline oriented with decent dividends, I thought they might hold up well. Not so. Thank you for any direction. Like many out there, at my age (65) and portfolio balance, being in the wrong place at the wrong time is harder to recoup from. thank you

  14. Chris | April 11, 2012


    Do any of you have an idea then and at what price US NG will turn back up?
    Today it passed 2USD and is currently at 1,986. I'm acctually thinking to buy long term since the price is so low I will never lose my investment as long as it doesn't hit 0.
    I have hard to believe it will be under 2USD in 5 years. What do you think?

  15. Tony Montana | April 21, 2012

    When the price of Natural Gas will turn up is anyone's guess. However, with rumours that we are close to over-capacity should basically decimate the price of Natural Gas in the next few months. Like the Author said there may be a temporary lapse where some Shale Fields enter into $0.00/mmBtu. This would cause the spot/futures prices to crater. Not until we see some type of capitulation will it rise. For now the outcome is still bearish, and I would say look for late fall to early winter to see a ramp up.

Leave a Reply

Your email address will not be published. Required fields are marked *

Some HTML is OK