Commodity Q&A: Winners and Losers in the Natty Bear Market

Q: Who wins and who loses with natural gas so low? Is there any play right now on it? – A.H.

 

A: In short, natural gas producers lose and natural gas consumers win.

 

Back in June, I warned you natural gas prices were in trouble and unlikely to recover. Now, we're at the point where producers become really marginal businesses. The better-managed ones are in for a rough time. The ones with lots of debt are probably headed under soon.

 

BreitBurn Energy Partners, for example, saw its line of credit slashed from $900 million to $776 million. It had to cut its dividend to stay afloat... and faces bankruptcy if natural gas prices stay low. Constellation Energy Partners and Quest Energy Partners are in a similar situation.

 

So I'd rather look at natural gas consumers for opportunities...

 

Industry consumes about 46% of all the natural gas produced. It's a fuel for electrical generation, incineration, and metal smelting. It's also a feedstock for chemical applications like methanol, plastics, and fertilizers.

 

Residential consumption ranks second to industry at 35%. Commercial demand ranks third at 19%. Commercial and residential consumers use natural gas mainly in heating, cooling, and cooking.

 

According to the Natural Gas Supply Association, there is a lag built into the prices paid by natural gas consumers, thanks to hedge contracts. A "hedge" is nothing more than a long-term contract at a set price (or range of prices). Most consumers don't want exposure to the daily changes of the spot market, so they'll lock in prices for months at a time.

 

That means many consumers haven't yet fully benefited from the declines seen in the spot price of natural gas, which is down 85% from its 2008 high.

 

As you can see in the chart, consumer prices were still fairly high in June (the latest data).

 

 

Industrial users saw the largest recent decline in prices, about 65%. Commercial and residential prices haven't fallen nearly as much, at 40% and 32%, respectively. That means the big winners in the natty bear market are industrial consumers like electric utilities and big agricultural chemical companies.

 

I like big chemical companies that use natural gas as a feedstock, like Dow Chemical (DOW) and Methanex Corporation (MEOH). I also like big energy companies that use natural gas to make electricity like Calpine (CPN). And fertilizer producers, like Agrium (AGU), consume a ton of natural gas.

 

Agrium swung from a $60 million loss in the first quarter to a $370 million profit in the second quarter. While all that can't be attributed to low natural gas prices, they surely helped.

 

You can take advantage of low natural gas prices with shares in power companies and fertilizer companies. But keep in mind, many other factors will determine the outcome of your investment.

 

I'm not convinced low gas prices can overcome a general economic slump in the long term... and most of these stocks are up big since March.

 

So the best way to play natural gas might be to run a gas pipe to your house and switch your utilities over, since residential prices are still falling.

 

Good investing,

 

Matt Badiali

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