This week’s figures from the U.S. Department of Energy (DOE) illustrate how significant changes in temperatures can impact natural gas – increasing both the draw on gas and its price. Released yesterday, these numbers provide us a glimpse of what the market looked like the previous Friday (in this case, January 7).

This is an important consideration in both the winter (when temperatures tend to dip) and the summer (when generating additional electricity to run air conditioners is the focus).

However, it also tells us something else. And this second lesson can be the source of a nice return for investors, as I will explain.

What DOE Data Tells Us

To nobody’s surprise, the cold snap engulfing virtually all of the U.S. (snow on the ground in 49 states!) has resulted in an increase in gas demand and a slight rise in average pricing.

[ad#Google Adsense]That pricing is determined by spot prices at Louisiana’s Henry Hub, the major confluence of pipelines providing the peg for gas NYMEX future contracts in New York.

In turn, those contracts indicate the price for natural gas equal to 1,000 cubic feet or one million BTUs (British thermal units) – the unit of energy needed to raise the temperature of one pound of water by one degree Fahrenheit. (A gallon of water contains eight pounds, for example. To raise the temperature of that gallon by 100 degrees, therefore, you would need to expend 800 BTUs.)

Anyway, the price of gas has been rising because of increased usage – but not by much.

As I am writing this, the current price for next-month futures contracts (for delivery in February) is about $4.45 on NYMEX; it has risen more than 33% since November 1 (the traditional beginning of the winter heating season). However, despite the rise in demand and the cold weather, the price is still more than a dollar below where it was at this time in 2010.

Now some places, such as the Northeast U.S., are paying much more than that, due to pipeline availability, distribution network problems, and a lot of snow to contend with.

Still, the usage of drilling rigs devoted to gas is declining slightly, and many companies are reducing capital expenditures for extraction programs.

This is merely a market attempting to balance forward production rates with expected demand.

Nonetheless, three things are happening here that will continue to provide an advantage to investors in natural gas production and distribution.

The New Niche Play in Energy

First is the move from coal to gas for the generation of electricity. This move will intensify the upward direction of returns for investors. As we have discussed before, there are new emission standards coming online in less than a year that will drive more usage away from coal – and into gas. Second, while residential usage levels may be flattening out once the current cold spell is over, industrial demand is returning. This was the last holdout from the protracted economic crisis.

Third, storage is now the play. (And this is the second lesson from the current situation I mentioned at the beginning.) The most recent DOE figures tell us that the U.S. natural gas stockpile has been reduced to below three trillion cubic feet.

That figure is still more than 5% above the five-year average. On the other hand, to put it in perspective, as long as this very cold weather lasts, the market will be drawing down at least one billion cubic feet per day from stockpiles.

Then again, the figures are well below the almost 4.7 trillion cubic feet in storage during October and November of 2009 – though, of course, demand at that time was much lower because of the broader market crisis.
The oncoming drive to develop additional storage capacity is the new niche play emerging for the investor.

In those areas of the country where usage has always exceeded production – the Northeast again comes to mind here – storage is a traditional play. The usual approaches have included both the development of underground facilities and the actual usage of previously operating wells as new storage sites.

These will certainly continue. But the market situation has changed considerably…

[ad#ChinaBlankCheck]The introduction of major production from the Marcellus Shale Play, together with the potential for even larger reserves in the deeper-lying Utica Shale, means the Northeast now has its own production, and volumes are already beginning to indicate a surplus above demand.

That moves the interest to storage, pipeline development (the vast majority of which is actually used for storage), and partnership structures emerging to provide both storage and pipeline management. This is now becoming the major new emphasis in this next stage of developing the unconventional gas promise in the U.S. market.

Central to the push are master limited partnerships (MLPs) set up to oversee pipeline and storage activities. Access to the pipelines remains the lifeblood of producers, whether they need to move volume from point A to point B or require a pipeline location in which to simply store the gas.

Either way, the MLP gets paid a fee.

These arrangements often issue exchange-traded notes (ETNs), providing the average investor both the opportunity to profit from the normal trading in the securities and an annualized return (an MLP must return all profits to the partnership; if the MLP has an ETN, that distribution also passes through to the ETN holder).

I expect to see an expansion in how MLPs operate, with such partnerships exercising a greater control over non-pipeline collection and storage systems, even to include the effective control over previously producing wells to be used as storage locations.

As the revisions in the U.S. gas market continue, therefore, this is likely to become a very interesting place for the individual investor.


— Kent Moors

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Source:  Oil and Energy Investor