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Bottom Fishing In Natural Gas

For most people, the fall of crude oil since the middle of last year has been the dominant story in commodities recently. You still hear much talk of a “freefall” and the like, even though the low for WTI was reached more than two months ago and oil is now trading at levels over 20 percent higher than it was then. For industry insiders and those of us who follow these things, however, the more scary collapse has been in natural gas.

That drop started while oil was still pretty buoyant back at the beginning of 2014 and has continued unabated ever since. The 2 year chart for natural gas futures is a pretty depressing sight.

It takes a brave man or a fool to attempt to find a bottom when a chart looks like that, but whichever of those you may think I am, I believe the time has come.

Actually I should add a third type of person who might want to attempt such a feat: somebody with a plan to control the risk, and I would put myself in that group. I will freely admit that I have nibbled at natural gas before and got burned, but regular readers will know that that isn’t for me, nor should it be for any disciplined trader or investor, a deterrent.

If your analysis shows logical reasons to believe that we should be near the bottom and if you are aware that you could be wrong and set stop losses accordingly, then you can, as I have said in the past, afford to be wrong a few times; losing around 5-10 percent on a trade with potential for profit much greater than that is okay. You don’t want to make a habit of it and keep doing it all the way down, however. Wait for a reason before jumping back in. Nothing ever moves in a straight line forever though, and some kind of a bounce in natural gas is inevitable. After such a spectacular fall it is likely to be quite strong when it comes too.

So, if I am looking again, what has changed? Well, two main things. Firstly, from a kind of stretched out technical perspective, these levels have formed a base before. If we stretch the chart out to 5 years we will see that that was the case back in 2012.

 

Of course, regular readers will also know that I am only too well aware that what happened three years ago in terms of price is often not relevant to today’s market, but in the case of commodities that is often different. Previous lows can frequently represent a level at which the supply/demand balance shifts. It can be where producers hit serious problems and close wells or mines in a hurry, or it can be where the cost benefits are too great for potential users to ignore. Sometimes it is both and when that is the case, a retracement from those levels can come quickly.

The second reason for renewed optimism is more fundamental. The export from the U.S. of Liquefied Natural Gas (LNG) in large quantities has been on the cards for some time, but new pipelines and the readiness of the Sabine Pass liquefaction and export terminal owned by Cheniere Energy are in the process of making that a reality. The pipelines have already led to an increase in exports to Canada and Mexico, while Cheniere expects the first shipment to leave its plant in January of next year. In addition, the likely ratification of the TPP, the trade agreement that President Obama wants, will make exporting even easier. Exporting matters because in most of the rest of the world, natural gas commands prices of $6 or $7, rather than $2.

Put all that together then and there is a logical reason to believe that the bounce is coming soon to an exchange near you. The best way to play that belief though, may be through the stock market. Chesapeake Energy (CHK) is the second biggest producer of natural gas in the U.S., behind only Exxon Mobil (XOM). Because of that it is no surprise that their stock has collapsed along with the commodity, from close to $30 a year and a half ago to around $7 now.

The thing that makes CHK attractive as a play if you believe that gas could be about to rebound, however, is that much of that drop has come as the result of short selling. Short interest in the stock now stands at over 11 days to cover, so any sign of a bounce in natural gas prices could easily produce a rush for the exit from a quite crowded trade…the classic short squeeze. The recent low of $6.01 in CHK also allows for a stop loss just below that level which would limit potential losses to around 15 percent.

That looks like a reasonable amount to risk in a trade that could become very profitable very quickly if things work out.




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