The Outlook Bodes Well For Natural Gas ETF Beyond 2009

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May 28, 2009 9:30am NYSE:UNG

natural-gas Natural gas prices have shown some strength recently, piggy-backing on higher oil prices. Although last week’s higher than expected gas storage update is bearish in the short-term for natural gas prices, the longer term outlook bodes well for significantly higher natural gas prices.

Although oil prices will also probably pull-back from the recent run-up with the technical outlook turning bearish in the short-term, if oil prices breach the US$50 support level, oil prices are likely to remain strong in the years ahead, which will help to support natural gas prices.

Despite the current over-supply of natural gas, the supply-demand situation is likely to achieve equilibrium over the next two years that will support higher long-term natural gas prices. Supply has increased substantially primarily due to reduced industrial demand during the recession and a warmer than usual winter in the north-east U.S. However, many natural gas exploration and production companies have reduced their drilling plans for 2009, which will result in less gas going into storage over the next two years. The supply-demand fundamentals are expected to improve considerably when industrial demand starts to pick up in light of reduced drilling.

The energy equivalency of natural gas compared to oil is generally 6,000 cubic feet to one barrel of oil, and the price for 1,000 cubic feet (1 Mcf) will generally trade for one-sixth of the price for one barrel of oil during normal times. As you are well aware, we are definitely experiencing anything but normal times in the current environment.

Over the past two years oil has traded for about 10 to 12 times the price of natural gas. With current prices for oil at about US$61 per barrel and natural gas at about US$3.40 per Mcf, the ratio is almost 18 to 1. Natural gas prices stand to benefit from closing the gap in pricing relative to oil prices.

Natural gas prices have spiked twice in the past four years and accompanied spikes in oil prices – in 2005 after hurricane Katrina hit Louisiana and during last year’s run-up in prices. Another price spike could occur when the supply-demand outlook improves.

An opportunity to benefit from a recovery in natural gas prices, particularly a price spike, is through the United States Natural Gas Fund (NYSE: UNG, Stock Forum), which invests in near-month natural gas futures contracts.

In the chart below note the significant downtrend in the price of UNG over the past year. The downtrend is still intact but the price is ripe for a breakout later this year, which could set the stage for a significant trend reversal.

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