Should You Buy a Three-Year Low in Natural Gas?

Sean Brodrick By Sean Brodrick, Resource Strategist, The Oxford Club

Oil & Gas

Just this week, the price of natural gas dropped to a new three-year low on the New York Mercantile Exchange. Is this a market extreme? Should you buy this drop?

The problem for natural gas is a mix of supply and demand. Supply is up 4 billion cubic feet per day year over year. That’s a rise of 2.1%.

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Natural gas inventories usually rise at this time of year. That’s because producers stock up before the winter, when consumption rises. This so-called injection season typically ends as we close the book on October. Consumers then draw on stored natural gas through the end of March.

The problem is traders aren’t expecting consumption to rise much this year.

Instead, weather forecasters are prognosticating warmer-than-normal weather in the coming months. That, along with a flood of supply, is weighing on prices.

However, I believe weather forecasters could be wrong, at least when it comes to natural gas demand.

Why? There is a strong El Niño – a long-term warm weather event – spinning around in the equatorial Pacific Ocean. Water in that part of the ocean is as much as 2.5 to 3 degrees warmer than normal. It turns the Pacific Ocean into a hot tub of sorts. And that means El Niño can get very strong indeed.

AccuWeather Meteorologist Brett Anderson recently said, “This El Niño will be one of the strongest El Niños over the past 50 years.”

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This strong El Niño is why Hurricane Patricia – which recently rampaged its way through Mexico – was the strongest hurricane ever recorded in the Western Hemisphere. Its winds hit top speeds of 200 mph! That’s because El Niño acts as a hurricane supercharger for Pacific storms.

So what does El Niño mean for winter?

For several reasons, that answer isn’t as simple as you might expect:

  1. El Niño is not the sole driver of the atmosphere or the weather at any time.
  1. No two El Niños are exactly alike.
  1. Scientists expect this winter’s weather will be different than normal; it will probably be stormier. But exactly how weather will change in different regions – and whether it will be warmer or colder – is more guesswork than science.

But based on past experience, here’s what scientists think. The northern part of America’s Midwest may experience milder weather than usual. Ditto for central Canada. California could get some much-needed rain, as well as snow in the dry-as-dust Sierra Nevada range.

Natural gas traders are extrapolating the “milder” forecast for the Midwest across the U.S. And maybe it will work out that way. If so, it’s priced in.

However, I’ll point out that the last time we had a strong El Niño, in 2009-2010, the East Coast was buffeted by frigid storms.

See, El Niño has a tendency to supercharge the southern jet stream with moisture. When combined with other weather conditions, this can trigger powerful coastal storms that pound the Northeast in the winter like an icy hammer.

So, we could see chilly air masses pile up on the eastern U.S. down into Texas. These factors could result in a corridor of snow from Texas up into the spine of the Appalachians.

A warm winter is already priced in. But if El Niño shows us its other side, that could light a fire under natural gas demand.

El Niño Versus the Blob!

But there’s another power at work when it comes to natural gas prices: “the blob.”

What, you haven’t heard of the blob? It’s a major ocean phenomenon.

The blob is a vast expanse of water with warmer-than-average temperatures in the northeastern Pacific Ocean. It has been more or less present since 2013, and scientists say it’s “the most significant factor” in the bitterly cold winters that slammed the Northeast in 2014 and 2015.

So El Niño may show up to party, only to find the blob has stolen the show!

What Looks Cheap

Naturally, you could put some gas producers on your shopping list. Look for those that aren’t too burdened by debt. My colleague Matthew Carr wrote about that recently.

But you should also look at pipeline companies, especially master limited partnerships.

Many of these are paid based on the volume of gas they transport. This means that as production goes up, as it is doing now, they make more money.

Yet many of these companies are being traded along with the price of natural gas. That means their stocks have sold off hard.

Oil and gas pipelines tracked by Yahoo Finance now sport an average dividend yield of 5.78%. Compare that to the S&P 500’s dividend yield of just 2%.

You can find some real bargains that will pay you big fat dividends. And if and when natural gas prices go higher, the pipelines should go along for the ride.

All the best,

Sean