Shorting Natural Gas Stocks

Thursday, September 03, 2009
We're Headed for a Huge Wipeout in Natural Gas

By Tom Dyson

Natural gas is plummeting...

Last week, natural gas fell to a fresh seven-year low... trading as low as $2.70 per mcf (that's 1,000 cubic feet).



The big fall came on Thursday after a report by the Energy Information Administration (EIA) showed natural gas producers had put another 54 million mcf of gas in storage last week. There's now over 3 billion mcf of gas in storage in America.

Here's the thing: I just read a transcript of the latest earnings conference call from Chesapeake Energy. Chesapeake is the largest independent natural gas producer in America.

One analyst asked Aubrey McClendon, Chesapeake's CEO, why he ramped up production recently even though gas prices had fallen so far. Normally, you'd expect the opposite. When you can't make a profit, you cut production to the bone.

McClendon said America's natural gas industry will have filled up all available storage by the end of the year. At this point, there'll be "involuntary curtailments." In a few months, the lack of storage will force gas companies to stop pumping gas.

In the meantime, McClendon needs to pump as much gas as he can before the storage caverns fill up. It's like a race to pick up pennies in front of a steamroller.

"We didn't see any reason to take it on the chin for the team," he concluded.

Over the last few years, the gas industry has borrowed billions of dollars and used this money to develop new gas fields. Natural gas companies have built refineries, ports, pipelines, drilling rigs, platforms, and storage tanks.

Even though the industry isn't making any money pumping natural gas at prices below $3 per mcf, it cannot cut production. These companies have to make interest payments and must earn whatever revenue they can get.

In other words, gas prices are falling because the industry keeps producing as much gas as it can, even though there isn't enough demand.

For now, this hasn't been a showstopper. The U.S. has a huge capacity for storing natural gas. The trouble is, the storage is almost full...

When the storage fills to capacity, there's going to be a storm in the natural gas industry. Many companies will be forced to turn off the spigots. Can you imagine what will happen to earnings at these companies? They'll collapse. How will these companies pay the interest on their debts?

Gas is cheap, it's clean, and it's made in America. Gas has a great future. But until the storage runs out and half the drilling companies go bankrupt, gas prices won't rise. There'll be too much supply.

Shorting overleveraged, high-cost gas producers is the way to profit from this situation. Many of these companies are going bankrupt in the very near future.

Good investing,

Tom

P.S. The EIA is publishing a report on the amount of natural gas storage still left in America. This report comes out in the next few weeks. I'll let you know when they publish it... and what its implications are. Keep reading.