Position: No position in portfolio currently
From a commodity perspective this year, we have been primarily focused on copper and oil over the last few months. This is driven both by our re-flation thesis, under which global priced commodities such as copper and oil benefit, and also our bullish stance on China, which is the home of the majority of incremental demand for these commodities globally. Lately, natural gas has started to come on our radar screens, but for vastly different reasons.
Unlike its use of oil, the United States is largely self sufficient in its use of natural gas. In 2007, the U.S. produced 19.3 billion cubic feet annually and consumed 23.1 billion cubic feet, for a net import number of 3.8 billion cubic feet. More than 95% of the net import number for natural gas comes from Canada, which in aggregate makes North America highly self sufficient in its production and use of the commodity. Unlike oil, the continent is not a net importer for natural gas.
The implication of this is that natural gas is a commodity that is priced much more on basic supply and demand versus oil which is priced partially on natural supply and demand, but also based on geopolitical risks and actions of regional cartels, primarily OPEC.
In the United States, ~28.7% of natural gas is used in the economically sensitive industrial sector. In economically weak times, demand from the industrial sector declines. In late 2008, it was a perfect storm for natural gas with a weak economy leading to declines in consumption combined with a natural gas production profile that was increasing at an accelerated rate due to high natural gas prices, which prompted more drilling, and due to a number of the large shale plays coming online. In the table below, y-o-y growth in natural gas production in the U.S. is summarized:
The key take away from the table above is that U.S. natural gas production growth on a y-o-y basis was well above its historical norm for the last 6 months of 2008. We calculated the CAGR for U.S. y-o-y production growth from 1990 to 2008 and the CAGR was 0.80%. The CAGR in consumption for that period was 0.96%, which implies that historically, at least for the last two decades, the industry acts relatively efficiently in terms of production additions. This 5.4% growth that we witnessed in the last 6-months of 2008 was well above historical norms. Not surprisingly, gas in storage is up 372 Bcf, or 22.4% y-o-y, as of March 20th.
The key to thinking about the inflection point for natural gas from a supply and demand perspective is to determine the rate of decline in drilling, which will lead to declining production that will push the market back into balance and obviously stabilize pricing. Over the next couple of weeks, we will be surveying some of our contacts in the natural gas fields of North America to get more perspective.
Daryl G. Jones
Managing Director
