Commodity Trade Mantra

Natural Gas May Rise within 12 to 24 Months

Natural Gas May Rise within 12 to 24 Months

Natural Gas May Rise within 12 to 24 Months

Jason Mayer joined Sprott Asset Management as a Portfolio Manager in November 2012. As the manager of a portfolio containing small-cap natural resource equities, Jason watches closely for the next potential winners in the natural resource market. He revealed to me that right now, one of his most bullish calls is on North American natural gas – with a timeframe of 12 to 24 months. Here’s the case:

Natural Gas production has increased as new natural gas wells were brought on-stream despite low prices.

Land banking essentially drove industry to over capitalize, resulting in a glut of wells. The increase in production associated with these new wells depressed the price.

“What we should see over the next 12 to 24 months is a peak in natural gas production followed by a decline. That should be very good for natural gas prices. The advent of fracking enabled industry to extract natural gas from shale. At the onset of the fracking boom, natural gas companies went into a frenzy building up their ‘land bank’ and drilling wells on shale prospective properties. They drilled wells because companies aren’t allowed to keep the lease on an exploration property for more than a few years. In order to convert land tenure from short term exploration leases to longer term production leases, industry continued to drill wells even as prices were declining.

“It’s important to understand that these companies are primarily concerned with securing the sizable resource associated with shale gas. Essentially, industry made an initial investment by drilling uneconomic wells but securing the sizable resource from which they will harvest returns over many decades.”

This dramatic increase in drilling activity created a massive inventory of standing wells, which are wells that are waiting to be produced, says Jason. “There were a significant amount of wells drilled that were not producing because the infrastructure to bring the gas on-stream was insufficient. So even as prices and drilling activity declined, production continued to increase.”

“Natural gas prices will benefit once the number of standing wells are depleted,” he continues. He believes this could take place within the next 12 to 24 months. “A large number of standing wells have been exhausted.  There continues to be a sizeable inventory of standing wells remaining in the Marcellus region – currently the region with the largest inventory of standing wells. The planned infrastructure initiatives in the Marcellus will increase takeaway capacity and should deplete this inventory of standing wells by year end.”

Natural Gas drilling activity is at the lowest level since 1995.

There is insufficient drilling activity to offset natural declines. If the current inventory of standing wells did not exist, production would be in decline. As new infrastructure drives the standing well inventory lower, natural declines should ultimately result in contracting production in the absence of increased drilling activity. As a result of all these factors we expect to see a positive response in natural gas prices within the next 12 to 24 months.”

So how do you position your portfolio to benefit from a natural gas spike?

“Buying natural gas itself will expose investors to seasonality and volatility, so we would own the companies that produce natural gas instead. The companies in our portfolio are low-cost producers with strong balance sheets, and large resources in place that generate industry leading economics. We believe that these types of companies will benefit the most from higher natural gas prices.

“The natural gas shale boom has attracted the majors – such as Exxon – that unlike smaller companies, have access to capital to finance the development of these resources. We expect deals between majors and smaller companies, such as the Exxon-Celtic transaction, to become more prominent within the next 36 months. Eventually, the majors will become more dominant in the Western Canadian Sedimentary Basin because of their longer-term investment horizon and access to capital. These behemoths require certain characteristics, particularly large scale and predictability of production, as they plan to harvest the resource over a multi decade timeframe.”

Natural Gas May Rise within 12 to 24 Months

Courtesy: Sprott Group

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