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To Frack or Not to Frack

A recent ruling by the New York Supreme Court, gave small towns in the state the right to ban the combination of hydraulic fracturing and horizontal drilling known as fracking. This ruling may apply to local governments across the state, but it is likely to spread nationally as many local governments fight to slow or ban the national shift toward gas production in the U.S. This ruling could seriously impact natural gas supplies in the short-term, but so far the market hasn’t reflected any major concerns. The long-term impact is still being studied.

Currently, states like Montana, North Dakota, Ohio, Oklahoma, Pennsylvania, Texas, Utah and Wyoming are benefiting the most from the natural gas boom. But a handful of states currently have legislation on the table that could ban or limit fracking and the disposal of fracking waste. These states include California, Colorado, Florida, Michigan and North Carolina. Even a few of the states enjoying the economic benefits of fracking like Ohio and Pennsylvania have a few activist groups fighting to control the amount of fracking taking place.

While environmentalist´s claim that fracking can cause groundwater contamination, soil contamination, sickness, and disease, those in favor of fracking cite the economic benefits to the states and local governments in terms of greater tax revenue. Consumers are also benefitting from the high natural gas supply in the form of lower heating and cooling costs. The natural gas industry estimates that over 1.7 million jobs are in some way related to the fracking industry. Some are even predicting if the current trend stays the course, another 600,000 jobs will be created by the end of the decade.

With the natural gas industry facing increasing scrutiny, it’s important to focus on your investment exposure in this industry and especially companies that are actively producing and holding leases in the states with favorable consumer and government support for fracking and natural gas as a major source of energy. While the current ruling is only governing two small towns in New York, its impact could spread nationally fairly quickly so the smart thing to do is make your portfolio adjustments before the news has a major impact on your holdings.

This Week’s Price Action

This week, Nearby Natural Gas futures declined to a seven-month low on July 17, falling below $4.00 a million British Thermal Units, after a government report showed U.S. stockpiles the week-ended July 11 increased at an above average pace.

The recent steady increase has erased all of last winter’s price premium while easing concerns of low supply going into this winter. Last year, the industry was caught short supply. This year with the help of mild summer temperatures and increased production, it appears the winter heating season will begin with ample supply on-hand.

 Graph natural gas futures.

During the week-ended July 18, Nearby Natural Gas futures were trading on the bearish side of a technical retracement zone. While the price is relatively cheap when compared against the winter levels, there doesn’t seem to be any buying interest from professionals or hedge fund managers.

Aggressive speculators may want to consider the long side of the market once it reaches the 2014 low at $3.92. This level may be attractive to value-seekers or it may serve as a natural area for short-sellers to begin taking profits. The key to trading this market is to wait for it to stop going down then assess the risk of a buy. Do not try to step in front of a falling market.

Fundamentally, Mother Nature is going to have to turn up the heat these last several weeks of summer to generate any professional buying interest. In addition, the possibility of a Gulf of Mexico based hurricane may also lend some support to prices.

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