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The Commodity Investor Q&ABy Matt Badiali, editor, S&A Resource ReportWednesday, November 4, 2009 Q. What is the better investment right now, oil or natural gas? – C.F.
A. Judging by the overwhelming feedback to a recent essay about the natural gas storage glut, natural gas has a vocal group of supporters in Growth Stock Wire readers.
I'm skeptical. For natural gas to pay off, we need consumption to go well above average and production to fall. It doesn't seem likely.
Last week, storage in the western U.S. went 12% above its listed capacity. In other words, we filled up more space than we thought we had. In spite of the record early snowfall in Pennsylvania and the blanketing out West, we still added 25 billion cubic feet to storage last week.
For the first time since 2003, a cold-weather futures contract (November to March) expired below $5 per thousand cubic feet. That's not a good sign for gas prices.
Right now, we have 3.7 trillion cubic feet of natural gas in storage. The difference between the highest peak in storage over the last five years to the lowest trough is 2.5 trillion cubic feet. So that's the off-the-charts absolute best-case consumption scenario for natural gas bulls... And we'd still end up with a surplus of 1.2 trillion cubic feet to begin next year – right where we started 2009.
The producers aren't helping. We found 29.5 trillion cubic feet of natural gas in 2008 – 9 trillion cubic feet more than we produced. We have 244.7 trillion cubic feet of proven natural gas reserves, up 3% over last year. That's the largest volume of reserves recorded since the U.S. Energy Information Administration (EIA) began keeping records in 1977.
In stark contrast, oil reserves continue to fall. We produced 1.7 billion barrels of oil in 2008 but found only 1.1 billion barrels.
Investors reward public companies for low finding costs (the cost to replace a barrel of reserves). Oil and gas companies report their reserves in "barrels of oil equivalents" (BOE), which means they can lump natural gas in with their oil reserves.
Right now, it's expensive to find new oil, but it's cheap to find natural gas. So oil and gas companies are producing oil and replacing those barrels with natural gas.
If you take the 30 largest public oil and gas companies, you'll see the trend: In 2005, oil made up 54% of their total reserves. By 2008, it only made up 49%. While total reserves have risen 6% over that period, oil reserves are down 3%.
To sum all that up, we have a record amount of natural gas in storage now. We need a record cold winter and record high consumption to get us back to 2008 levels of gas supply. We're looking for new ways to get rid of the stuff... But Wall Street analysts are all but demanding companies find more gas. Together, it paints a bleak picture for natural gas prices in 2010.
On the other hand, we have declining oil reserves. Oil is expensive to find. The easy barrels are gone. We must look to alternative sources like the tar sands and ultra-deepwater.
At the same time, global consumption can't fall far. We must have oil to fuel our planes, ships, trucks, and trains. Countries like India and China are just beginning their love affairs with cars.
If you are a long-term energy investor, you absolutely must own oil. There will be opportunities in natural gas. But the low-risk investment today is clearly oil.
Good investing,
Matt Badiali
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