Weather Forecast Looks Bright For LNG But I’m Skeptical

For a lifetime trader of fossil fuels, it's been like living in the dark.  I've never seen a better market to be long crude oil, where the risks to the upside were, to me, exponentially deeper than the possibilities to the downside - but my shrinking profit and loss statements have been a contrary indicator to be sure.

Natural gas has been almost the exact opposite, where downside risks are far more numerous than the possibilities for a big move higher.  And yet, nat gas is showing some surprising strength, considering the moderate summer we've just come through.  As with crude oil you have to ask - what is going on?

One chart I love to start the conversation on natural gas is this one, from the Energy Information Association:

Even for those of you who are aware of the shale revolution in the US, this serves as a fantastic representation of just how incredible the growth in gas production has been here in the US.

And remember: while US crude demand will never be satisfied by US production, natural gas production from shale has almost completely satisfied what the US uses - and ultimately the excess that gets produced has nowhere to go.  

Sure, there's been hopeful talk from natural gas advocates about a conversion in the US to a 'gas-based' energy infrastructure:  transport trucks and cars running on US shale gas, utility plant conversions, gas-to-liquids projects and a very interesting new technology of GTL (which I'll get to another time).   But for all the opportunity that "Saudi America" seemed to hold in the last several years, very little has actually progressed forward, and not nearly enough to soak up the parabolic growth in production you see in the graph above.  

So, why is nat gas hovering still near $4/mcf?  The fundamentals for natural gas look almost as bad as the fundamentals for crude oil look good:  With stockpiles again above the 5-year average and with the two straight months of sub 90-degree summer temps, many a trader (including me) expected prices to substantially sink below $3.50 coming into the fall.

So what's happening?  

Here's my take on it, and as usual, it concentrates away from the fundamentals and almost entirely on the financial inputs into price.

Last year saw one of the most brutal winters on record, with 6 straight weeks of sub-freezing temps in the Northeast - an almost unheard of cold snap - driving natural gas prices briefly above $6.  

You wouldn't believe it (I don't), but several of the long-range weather forecasters are predicting a winter equivalent to 2013 - and some are looking at temperatures even more severe.  

I imagine that the commodity hedge fund players are happily ignoring the fundamentals of rapidly increasing supply (and infrastructure overloads), and making a very calculated risk/reward trade on natural gas at under $4/mcf :  Catch a winter like last year and make perhaps $2 on a spike or don't get one and risk perhaps 30 or 40 cents.  

This might be a great reason to trade some futures, but I cannot recommend a natural gas stock from it - in fact, all of the Marcellus plays that I normally follow look like very difficult buys here including Southwestern (SWN), Range Resources (RRC), Cabot (COG) and EQT Corp (EQT).

I hate the weather trade - can't trust it.  Because of that, I'm staying clear of natural gas stocks right now.