Under the Radar: Navigating Natural Gas
By Christopher Edmonds
Special to RealMoney.com
09/05/2003 12:00 PM EDT
One ardent energy bull has turned a bit skittish about the short-term direction of the energy markets.
Marshall Adkins, director of energy research at Raymond James and a member of the TSC Energy Roundtable, is well-known to readers of this column as one of the more colorfully bullish pundits on the Street. And with gas prices rising above $6 this past winter and holding firmly above $5 until recently, his bullishness has been well-placed.
But while Adkins' longer-term bias remains on the bullish side of the aisle, recent comments suggest he's less than sanguine about the coming month for energy investors.
"We continue to trek down what we believe is the long road of a multiyear secular upturn in the oil patch," Adkins recently told clients. "However, most long trips are not completed without encountering some bumpy patches in the road. This is exactly what energy investors should be braced for in the upcoming weeks as we enter the September shoulder period."
His argument is based on the observation that September has historically been a month of large injections of natural gas into storage. For most energy investors, that should be intuitive: Demand for air conditioning slows as summer turns to fall, yet heating demand has yet to return with cool temperatures.
"Normally, the months of April and October contain a significant amount of heating degree days as winter winds down or ramps up," Adkins noted. "On the flip side, the lowest number of degree days (or the mildest weather) typically occurs in June and September."
Without unusual weather, that could mean large natural gas storage builds in the coming weeks. "The lull in degree days in the spring and fall, known as 'shoulder seasons,' typically equates to the largest weekly injection periods of the year," Adkins suggested.
Adkins believes those injections could be as large 90 billion cubic feet a week over the next couple of weeks, which may catch the markets by surprise, sending both natural gas prices and energy stocks lower, at least until signs of heating demand begin to creep back into the weekly storage data.
While Adkins' argument is based on strong precedent, only a modest departure from the norm could create a scenario in which September storage results come in lower than expected.
As an investor, my first focus would be on the tropics, where tropical storms and hurricanes in September could have a marked impact on the supply of natural gas available for storage. While forecasting is not an exact science -- far from it, many would scoff -- one of the leading tropical forecasters suggests that September could be an active month in the Gulf of Mexico.
Dr. William Gray, director of the hurricane prediction center at Colorado State University, is forecasting that four tropical storms will hit the Atlantic in September and three more in October. The September forecast calls for four storms, including two hurricanes, one major hurricane and a lesser tropical storm. Both U.S. and Caribbean basin landfall probability is expected to be slightly above the long-term average. While the location and magnitude of the storms are important to their impact on natural gas production in the Gulf, the impact of two storms there in 2002 provides some evidence of the disruption that can occur when a storm swirls in the Gulf.
My second focus would be on weather-related demand, specifically early frosts in the upper Midwest, Rocky Mountains and the Northeast. Snow has already glistened in the mountains and foothills of Colorado, and some forecasts are talking about an early fall in the Great Lakes region. An early and cooler-than-normal fall -- especially in the Rockies region, where natural gas production would then be used for native demand rather than storage -- could also affect storage reports in September. Of course, an Indian summer in any region of the country also could extend the cooling demand season and the heat-related demand for natural gas.
As noted in recent columns, the shoulder months are an interesting time to invest in energy. While Adkins' argument is one side of the coin, the flip side is that investors begin to look ahead to the heating season in September, and this renders the storage numbers less important.
In fact, with nearly everyone convinced that natural gas storage will approach the 3 trillion cubic feet level by November -- the traditional beginning of heating season -- it's possible that many investors will pay less attention to the absolute level of the September weekly storage numbers -- a possibility Adkins acknowledges.
"This logic pattern assumes that the gas market is not smart enough to figure out that higher injections are coming our way," Adkins quipped. "Over-full gas storage and a subsequent gas-price collapse aren't likely to happen. As the market begins to figure out that the notion of full storage and its implications for gas-on-gas competition have subsided, we expect a return in focus to the upcoming winter season to transcend."
The Bulls of Winter
While Adkins provides a modest dose of short-term caution, he remains bullish as fall turns to winter and seasonal demand begins to again draw on natural gas reserves.
"We expect firming natural gas and energy stock prices to develop as we move through October and into the winter withdrawal season," Adkins said. "Based on current oil product prices and low inventories, this means that natural gas prices should hold to a floor of low-$5/Mcf [thousand cubic feet] this winter, with significant potential for upside if we get cold weather."
It's important to remember that while natural gas storage may be close to full by the beginning of the November heating season, it was filled with gas prices at or above $5 per Mcf for most of the injection season. In other words, with storage filling to a comfortable level at higher prices, those who are holding gas in storage are expecting to get the traditional winter premium -- meaning price above the price at which gas was stored -- for gas they have for sale.
This suggests that if energy prices -- and energy stock prices -- weaken in September, the weakness will be only temporary.
"We do not expect natural gas prices to dip into the $3/Mcf range as many expect," Adkins notes. "Once the market figures this out and begins to focus instead on the winter withdrawal season, we would expect firming natural gas and energy stock prices. Accordingly, any significant weakness that occurs in the face of the short-term noise would present an outstanding buying opportunity for longer-term energy investors."
And of course, Adkins always has his favorites in the oil patch. Names he says are most levered to North American natural gas production include Grey Wolf (GW:NYSE - commentary - research), Grant Prideco (GRP:NYSE - commentary - research), BJ Services (BJS:NYSE - commentary - research), Nabors (NBR:Amex - commentary - research), National Oilwell (NOI:NYSE - commentary - research) and Patterson-UTI (PTEN:Nasdaq - commentary - research).
On the exploration and production side, his natural-gas-levered plays are Chesapeake (CHK:NYSE - commentary - research), EOG Resources (EOG:NYSE - commentary - research) and Tom Brown (TBI:NYSE - commentary - research).
He rates all of the stocks strong buy, except BJ Services and Chesapeake, which are rated outperform. Raymond James expects to provide or attempt to provide investment banking services to all of the companies mentioned.
September could be an interesting month. However, if Adkins is right, it's more an academic exercise in timing than a real reason to worry about a bullish bias toward the energy markets.