How to Play A Potential Bounce In Natural Gas

Over the last year or so, probably the most spectacular move in any energy-related market has been the collapse of natural gas (NG). The price of front-end futures in the commodity peaked in August last year at just a shade over $10 before turning tail and dropping to a low of just below $1.95 a month or so ago. A big move like that requires a perfect storm, of course, not just one factor. An unusually mild winter in most of the US reduced demand for gas used for heating and electricity generation, for example, and the expected shortage as Russian gas was supposedly taken off the market never really materialized, but the biggest reason for the shift in sentiment is the most basic, and as old as the hills…the relationship between supply, demand, and price.

Price increases dampened demand for natty, just as production ramped up. Depending on where you get your news, that increase in output may surprise some people. I mean, aren’t fossil fuels in general supposed to be under siege from the Biden administration? Well, yes, but so far, the attacks have been verbal and rhetorical rather than practical, and market forces have done their thing regardless. When gas hit $10, it encouraged big output increases, such that 2022 was a record year for US natural gas output and storage became a problem as demand started to falter.

There are, however, signs that that is changing…

There is always a time lag in these things and there are seasonal variations, but over the last couple of months, it looks like natural gas output is beginning to adjust to the price drop, just as it did to the price rises early last year. There is still a long way to go before the market tightens, with the latest numbers showing storage running nearly 20% above the five-year average, but markets look forward, so a bounce back in NG looks to be on the cards before too long.

As always, though, the next question is how to play the expected move, and in this case, the simplest choice, buying NG, may not be the best. This is a longer-term play, so the short-term nature of futures trading makes it unsuitable. Instead, I will be buying and holding a stock that can benefit from a price increase, but also benefits to some extent from current conditions…Cheniere Energy (LNG).

Cheniere is primarily an exporter of natural gas, but also owns and operates pipelines and storage facilities. That infrastructure role is why the stock has held up quite well as natty has collapsed, and it gives some downside protection to investors while waiting for NG to recover.

A week or so ago, LNG did the thing that most perplexes investors when the stock dropped after they beat expectations on top and bottom lines in their Q1 earnings and increased their guidance for the coming year, presumably because even the good results and commentary didn’t beat the whisper numbers that preceded the release. That, though, is a short-term trading reaction, and as analysts adjust their estimates to the new guidance, a recovery will come. In addition, a move up is certainly justified on value metrics, with LNG currently trading at a trailing P/E of 4.6 and a PEG ratio of 0.58. Even without a pop in natty, one could argue on that basis that LNG was a buy, but if the current overall output trends in natural gas continue and the price does bounce back as expected, long LNG will be a position with sustained upside for many months to come.