Yesterday we added a long position in oil to our portfolio and gave a brief synopsis of the investment thesis in a follow-up research note. The primary bullish factor in the longer term for oil, as we noted yesterday, is supply. Global supply is constrained by almost any measure. Some argue that Goldman Sachs manipulates the price (we heard this the other day), and maybe these pundits are correct, but the reality remains that there are serious supply issues globally for oil based on the current normalized demand picture.
Conversely, natural gas is exactly the opposite scenario. The primary issue facing natural case pricing in the United States is natural gas supply. Natural gas is primarily a local market, and therefore priced locally, with the swing factor being the increasing global supply of LNG (liquefied natural gas).
Domestically in the United States, natural gas storage is well above the 5-year average. In fact, as of the most recent report from the Energy Information Administration, natural gas in storage in the United States is 12 percent above the 5-year average.
Interestingly, the EIA expects natural gas consumption to increase 1.9% year-over-year in 2010. In contrast, the current pace of production growth over the past six months has averaged 4.4%. Needless to say, the combination of above average gas in storage with production growth outstripping projected demand, will be bearish for the price of natural gas.
LNG will also create a bearish overhang on the price of natural gas in 2010. By some estimates, a 1% change in global liquefaction impacts global supplies by approximately 360 mmcf/d. According to the IEA, from a mid-2009 report, LNG supply globally will increase by 50% between 2009 and 2013. This will be a massive increase in supply, with the marginal amount being exported into the United States.
Below we’ve charted the price performance between oil and natural gas in the year-to-date, and the bifurcation is very clear. We would expect the next couple of quarters to continue to be A Tale of Two Commodities.
Daryl G. Jones