Why the price of gas will soon need to double

As the world climbs out of recession, commodity prices are beginning to soar once again. But one of the most important raw materials has failed to join the party. That is natural gas.

Financial speculators have had their knives out for gas, shorting the commodity and betting that it will remain out of favour.

A quick look at the price of natural gas since January shows how right they have been. The price on Nymex was $6 per mmbtu at the start of the year. Today it is just $4.

But this is more than just a passing fad. The price of gas relative to oil has been going down for years. Today it is half the level of five years ago.

This seems strange. Gas, after all, is a relatively clean, easily transportable fuel. So what is the problem?

The problem centres on shale gas and how this affects the global price of gas. Let me explain…

How shale extraction has dampened the global gas price

Since the Texas oilman George Mitchell discovered an efficient method for extracting gas from shale rock in the 1980s, the gas industry in the US has grown enormously.

Thanks to the huge Marcellus shale gas field in the north-east of America and the Barnett, Woodford, Haynesville and Fayetteville fields in the south, the US could be self-sufficient in gas for decades to come. And although your domestic gas bill may make you doubt it, this has been driving down the gas price worldwide. Here’s how.

While most gas is transported through pipelines, it is gas in the form of ship-born LNG that determines the global price.

LNG tankers leaving Qatar will sail to wherever they can get the best price, maybe changing course several times en route. Because it can be used to replace local sources of supply, it will ultimately set the price.

What is happening now is that, finding no takers in the USA, those Qatari tankers are turning to Europe and the Far East – and dampening the gas price the world over in the process.

So gas would appear to be as out-of-favour as it’s ever been. But investors should be on the alert for this to change. Some experts think that the price of gas is too low and are predicting an about-turn for the commodity.

Why the price of gas will soon need to DOUBLE

One man advising the gas price bears to reverse their positions is veteran commentator Henry Groppe. He says that gas is “greatly undervalued, based on fundamentals”.

US gas production, Groppe points out, actually peaked 40 years ago. And in his view – and in spite of those shale sources – “will inexorably decline”.

Shale gas, he says, “would appear to overturn everything, but in reality it accounts for only about 13% of US gas supply”. Furthermore, he argues, some 60% of this supply comes from the Barnett field, where production peaked a year ago and is now in significant decline. So while production from other shale sources is increasing, “everything else is in decline”.

Accusing gas market speculators of a “lack of understanding”, he says that there is a “misinterpretation that shale gas supplies will flood the US with natural gas”.

Groppe argues that the low gas price will lead to an increased demand, especially for power generation. At current prices it is more attractive for power stations to burn gas than coal, and Groppe believes that this will lead to increases in demand for gas “that is simply not available”.

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What’s the upshot of all this? Groppe says it is that prices will need to double to moderate demand.

This view is apparently shared by Exxon Mobil Corp. In December, Exxon shelled out $31bn to buy gas producer XTO Energy.

It’s a view that’s also shared by ConocoPhillips. Its chief executive, Jim Mulva, recently told a New York conference that “we see natural gas prices in the short term somewhere in the neighborhood of around $5, but ultimately longer term we see it more in the $6 to $8 range”.

So this looks like a very interesting time to be taking a contrarian view on gas.

So far as the UK stock market is concerned, the giant is BG Group (BG.). But, as ever, the best plays are among penny shares. These include Algerian gas play Petroceltic (PCI) and Texas-based Caza Oil & Gas (CAZA).

But I have identified two other exciting prospects – one that is about to drill what could be a company-making gas prospect in New Zealand; and a second that sits on what could become one of the largest gas fields ever found in Asia.

I think these are two great plays on what could turn out to be a major upturn for gas stocks. You can find out all about these companies in the May issue of Red Hot Penny Shares. Sign up here to make the most of this great opportunity.

Good investing,

Tom Bulford
For The Penny Sleuth

Red Hot Penny Shares is a regulated product issued by MoneyWeek Ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you’ve bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3780.

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