Natural Gas.. The last great American bargain

I am struck by how low the price of natural gas is.  The price is a victim of oversupply with under-demand and is a lesson about the economics of commodities. Here is a chart to show you the NG contract price action over  over the last 10 years.  The 2005 peak was the result of the hurricane Katrina year where natural gas production was shut down and we quickly learned that there was very little in the way of natural gas workaround and distribution.  The peak in 2008 was sympathy for the oil peak.

Here is the same time span for the CL futures or oil.

Excepting for the peak in the 05 pricing in natural gas, they mirror each other pretty closely. Currently natural gas is underperforming oil as it is hit by a double whammy of over-supply and decreasing demand.

The 05 and 08 peaks increased the pressure for discovery and infrastructure improvements for the production of natural gas.  The 05 peak was a supply issue caused by the “too many eggs in one basket” problem.  Too much of our natural gas infrastructure was located in the hurricane target zone.  Once shut down after a record breaking hurricane season in there were no real contingency plans, hence a shortage that could not be filled no matter the spot price of the product. Unlike oil, which has a gigantic international distribution system via  tankers, natural gas which is mostly home grown and distributed via pipelines. There are very few LNG tanker or ports setup to accept them. The shortfall for oil after Hurricane Katrina was quickly supplied with tankers turned for quick profits toward the fill spouts at America’s ports.

The solution for natural gas post Katrina was to beef up supply and re-distribute infrastructure weak points.  The ‘08 spike produced even more investment into natural gas exploration and distribution.

Then the recession and a plunge in demand while supply was going up and hence record low prices for natural gas.

Natural gas is a local product and is not bid up as a result of the following dollar.  We can not export natural gas to China or India, it is consumed where it is produced, right here in North America.

We now have what is currently a BTU arbitrage.

The purpose of energy products is to exploit their BTU content (energy). We do that by combusting the product to produce steam for electricity, heat for our houses or to drive the engines in our cars, trucks, planes and trains. So which is the most $ efficient. (this is not a green, global warming article.. it is a compassion of fossil fuel choices).

Looking at the current price and the BTU content of each and comparing on a BTU to BTU basis produces the following chart:

Chart of BTU per dollar comparison of OIL vs.. Natural Gas vs.. Coal vs.. Electricity.

(pricing as of December 4th, 2009) 

Using Oil as the norm for the comparison it turns out that natural gas, when compared to oil on a BTU to BTU basis, is almost 3 times cheaper.  Coal (a little impracticable for cars) is 6 times cheaper!  Even electricity is cheaper than oil. (The cost of electricity  is averaged across hydro, nuclear, natural gas, coal.. very little oil is used in the production of electricity).

If you want to profit from this arbitrage, switch your house over to natural gas if you have the option and convert your cars to natural gas.  Our cities are already doing this for their public transportation.  Switching to natural gas has the added benefit of being cleaner for the environment (there is very little sulfur and other bad stuff in natural gas) and best of it is American made (along with Canada).

Hint: Use the NG contract as a tell on the American economy as the recovery strengthens so should the demand and the price should start to rise.

-RLT