No end in sight for natural gas slump

Even as oil prices (OILC-I72.681.351.89%) surge on signs that the worst of the recession is over, natural gas (NGAS-I3.930.236.07%) is mired in a bear market brought on by weak demand and excess supply.

The fuel used by factories and power plants closed yesterday at $3.71 (U.S.) per million British thermal units, down 34 per cent this year and off 73 per cent from a 2008 high of $13.69 last July. Oil, meanwhile, has risen 60 per cent in 2009.

Even with natural gas trading near a six-year low, few expect it to bounce back any time soon. "I still think there's a bit more pain to come," said Martin King, research analyst with FirstEnergy Capital Corp. in Calgary.

Why are gas markets so glum?

The short answer is there's too much gas. Increases in gas production in recent years, principally from new shale plays in North America, have contributed to a dramatic increase in U.S. inventories.

U.S. stockpiles of the fuel totalled 2.337 trillion cubic feet in the week ended May 29, which is 22 per cent above the five-year average for this time of year.

Exacerbating the supply glut, the recession has cut demand from gas-fired power plants and industrial users. What's more, mild spring temperatures have meant many homeowners aren't turning on their air conditioners, removing a key source of demand for gas-generated electricity.

"The pricing picture for natural gas remains unpleasant for the near term, with the only hope coming from either sustained heat waves and/or hurricane disruptions, neither of which are on the short-term forecasting horizon," Mr. King said in a note to clients.

Historically, oil and natural gas have loosely tracked one another, but lately that relationship has broken down. While oil - a global commodity - is responding to improving demand from the Far East, natural gas - a domestically traded commodity - is facing bearish fundamentals in North America.

With prices so depressed, is now the time to buy? For investors with a short-term horizon, the answer is no. But for longer-term investors who can tolerate volatility, this could be a decent entry point, analysts say.

"The price is pretty low, but ... natural gas has already made a couple of attempts to get back above $4 and it comes tumbling back because the fundamentals just don't provide any underpinning for that kind of move," said Gene McGillian, analyst and broker at Tradition Energy in Stamford, Conn.

Natural gas could rally, however, if the North American economy shows sustained improvement or if next winter ushers in colder-than-normal temperatures that boost heating demand, he said.

One hopeful sign is that depressed prices are discouraging some natural gas producers, which should ultimately help to bring down inventories. The U.S. Energy Department forecasts that natural gas production will drop 1.1 per cent this year and 2.6 per cent in 2010.

Richard Wyman, senior oil and gas analyst with Canaccord Capital Inc., said investors who buy natural gas companies now could benefit when the price ultimately recovers. Stocks on his "buy" list include EnCana (ECA-T62.990.711.14%), Celtic Exploration (CLT-T16.430.563.53%), Progress Energy Resources (PRQ-T11.600.443.94%) and Fairborne Energy (FEL-T4.18-0.03-0.71%).

"In the short run, it's not going to be very pretty. I would expect that until we get much closer to the heating season, gas prices probably are going to remain quite weak and they could even get weaker before they actually get better," he said.