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Don’t Get Sucked Into Natural Gas.
I always thought that a great strategy for a new hedge fund would be to only buy positions from existing hedge funds that were blowing up. That fund would buy securities subject to margin calls and distressed liquidations, which are by definition at six standard deviation extremes. It would not trade very often, but few it executed on would be humdingers.
If I were running such a fund today, I would be getting reading to short natural gas. Big bets that natural gas would go down have cost the Bristol Energy Fund and SandRidge Capital 15% in the first half of this month, while five funds run by Morgan Stanley have been clocked for $120 million.
The harsh reality is that hedge funds that had been running big, successful shorts in natural gas had a terrible month in May. Margin calls from other losing positions, especially shorts in the Treasury bond market, have forced them to free up cash by buying back natural gas.
There has been a lot of talk about using CH4 to bridge our way to a carbon free economy because it produces half the CO2 that coal does. But virtually nothing has been done to put the infrastructure in place needed to consume the newly found 100 year supply in the US. To burn significantly more of this simple molecule, you need vastly more pipelines, power plant conversions, and above all, storage, than we have now. So far there has been a lot of talk (thanks, Boone), but little action.
Until then, the big production companies, like Chesapeake Energy (CHK) and Devon Energy (DVN) are going to race to out produce each other, praying they can use volume to offset price cuts, creating a huge weight on prices.
When natural gas was trading at $6 at the beginning of the year, I warned readers to stay (click here for the call at http://www.madhedgefundtrader.com/january_4__2010.html ). Gas then launched into an agonizing, three month plunge, where it lost one third of its value. The ETF (UNG) did even worse, spiraling down 38%, as the widening contango decimated investors. (For an explanation of how this works, please click here at http://www.madhedgefundtrader.com/march_5__2010.html ).
Since April, battered CH4 has rallied 25% off its $3.80 low. Talking heads on TV have explained this is because of the coming summer power demand from conditioners, the onset of the hurricane seasons, the imminent passage of a gas subsidies in congress, or because of crude supply shortages caused by the deep water drilling ban.
Don’t believe a single word of this. The supply overhang and storage shortage for this diminutive molecule is still as bad as it ever was. If we can claw our way back to the last cycle high of $6.20, I think natural gas would be a screaming short again.
To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two and a half years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.
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My son works for a large service co with a leading position in onshore frac support. He reports a large jump in onshore tight gas rig activity. IMO, operators fear much more regulation/cost in onshore drilling in the future. So they are trying to get ahead of the curve and get production online before the EPA puts its heavy boot on the throat of the domestic drillers. As gas production increases, prices will drop. As the the EPA regulates frac drilling due to the risk of contaimation of the drinking water, the price of natgas will soar.
A shortage in storage capacity = low prices. Who ever would have thought. (ridiculous)
Stick to your HFT alogo BS trades ... you'll never cut it in the energy industry
Nice, timely article. Thanks !
I believe in Natgas for the long run but you are probably right that too many entered into the market believing too much too soon without there being underlying support/infrastructure.
When countries like India and Rwanda can power their penal instutions on nat gas from human waste though...well it is a sign that it will be available without a complete infrastructure and can be independent of big companies to produce and bring to market.
Australia is harnessing methane from pig poo, California is using cows, Edinburgh is using landfil methane. The industry for sure is growing but for limited power supply useful to those in close proximity to the source.
I believe in natgas for contracting/development companies not the commodity itself because...well everyone/everything makes their own.
Mad is an understatement.
That toothpaste that you're purchasing in Chinatown DOES have mercury in it.
The only way to slay the deflation dragon is to pinch the crude supply. Increases in transportation costs is the surest way to have real price inflation. That is happening now. When it works it's way through the supply chain unleaded will visit $4.50 - $5.00 a gallon and natty will be riding shotgun.
Supplemented by blowhards in Congress, the bamster's lame admenstruation, and the exhalations of MSM, the surplus of Natural Gas should have it priced in pennies.
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Thank you for the good article, I completely agree, while hot temps and promises of an active tropical season have been an underlying supportive factor, the ramp up was largely a short squeeze in bear spreads; the prompt months rallied heavily while deferred's hardly budged. Supply is at/near record highs with more increases likely over the coming months, the swinging side of the equation is demand.
Yeah, buy retailers and financials... plenty of demand there.