In my November article I pointed out that gas again turned cheap and “I am changing my position to long-term, hoping for the third raid this year”. After big falls and with 4 USD it was good point to start investment at the moment of writing this article.

Life has verified this prediction and it turns out that gas now is even cheaper falling in the areas of two-year lows at 2,67USD/mmBTU. Frankly I wasn’t suspecting that this is possible.

After dropping below 3,5USD I intensified my purchases and now I am in the red. What to do in this situation? Definitely, not panicking! Get back to basics and use common sense.

1. Last 5 years increase of supply of gas was based on the US shale revolution. Cost of production from hydraulic fracturing (fracking) was a lot higher than the gas price itself. How it was possible than given that every mmBTU produced was making a loss?

Because of zero interest rates served by the FED bonds of oil and gas production companies offered 9-10% and was great deal on the debt market. Investors lulled and hypnotised by the vision of new Qatar or Saudi Arabia did not think through economic sense of suing this capital.

As a consequence loss generating companies went ahead with their production fuelled by Wall Street easy capital.

Today we have a situation where the amount of debt with ‘junk’ tag (CCC rated) which significant part of is coming from energy sector crossed threshold of 2 trillion USD. For comparison it is triple the amount of the MBS (Mortgage Backed Securities) that spawned the 2008 meltdown.

With falling oil price, market slowly realised growing risk of junk bonds made in USA.

The chart below presents value of the US index specialising in junk bonds.

Source: finance.yahoo.co

If low price of oil and gas will persist production companies will face bigger than ever troubles in acquiring capital. Right now number of them fights for survival and what number of them already filed for bankruptcy. This could be a start of end of an era of cheap capital for shale. Factor everyone must consider is additional wave of capital from FED after possible fourth round of QE. Saving energy sector could be perfect excuse to start printing machines again.

2. Oil/gas ratio

From 2011 to 1st half f 2014 oil price oscillated between 90 and 115 USD. Gas prices bounced between 2,6 and 6 USD. With oil/gas ratio at 30 kilojoules burnt from oil were 40 times more expensive than those from gas. This lead to situation where significant share of industry switched from oil production to cheaper gas. Increase of gas at the expense of oil resulted in their ratio falling down to 20 (as of now).

Source: stockcharts.com

3 oil price

I forecasted price of oil in the article “What happens with oil price?”. In my opinion today’s prices cannot hold longer than year or two.

Situation in the oil market is characterised by the table below showing the conventional oil production peaks.

Source: Thomson Reuters

This is worth analysing as the production form conventional sources is falling companies will reach for unconventional sources with higher costs of production. Either price will return to high levels or unprofitable part of production will cease and laws of demand and supply will correct price.

In this comparison big unknown is ISIS selling oil blow market price. Using military help from the US they can hold onto power longer than we could expect and effectively drag prices down on the global market.

4 Renewable Energy

I hear more and more about exchanging fossil fuel (oil, gas etc) with renewable energy. Topic is open but until now renewable energy has very small share in energy portfolio.

Undoubtedly with each year renewable energy will increase its hare in the energy mix. This process will speed up as two biggest automotive concerns released 3 thousand alternative energy patents for free. This change will take time. In 10-15 years 50% of cars will use alternative sources of energy other than hydrocarbons but in 2-3 years there won’t be any sudden drop of demand for oil and gas.

Summary

Gas in 2013 could give you 30% profit. Year 2014 was even better until November when huge drops occurred. Can natural gas fall below levels we see today? No one knows that. The fact is that no company producing shale gas can cut costs to be efficient at 4 USD. This additional supply correlated with surplus production of shale gas negatively affects price of natural gas.

My personal guess would be that behind gas slump there is big speculative capital. The same applies to increase of gas price to 6,5USD one year ago. Gas, like I mentioned before, started becoming a highly speculative commodity. We should brace for a lot higher prices. Those will follow oil prices coming back to their former levels. Patience, patience and patience shall be our friend.

Trader21