Diary of a Financier

Long Natural Gas

In Capital Markets on Thu 26 May 2011 at 00:06
  • Closed my second big gain in HK–so far my preferred vehicle for Nat Gas exposure–but I’ll keep watching it as a buyout target.
  • Opened UNG position @ $11.20 because of bull confirmation.
  • Front end NG futures curve trading with sensitivity to fundamentals still; no institutional presence until 2015+.
  • There’s a big arb spread between US NG & International NG, because the US lacks export facilities.
  • The US actually has a [little known] “Short Supply Control” export ban on crude oil & natural gas.
  • The NG fundamentals changed on 5/20 however, when Cheniere Energy received approval to export NG.
  • Cheniere rallied +31%, but spot NG faded the entire development.

I rode the Natural Gas ETF (UNG) for its most volatile swings at the end of 2010. After closing out my position with a thin gain, I decided to sit with Petrohawk (HK) as a better medium of Natural Gas (NG/1) exposure in 1q2011. This was my second round with HK, and in no time I had my second big gain in it as it quickly rapped my $26.75 target. I’ll keep watching HK, because some big player will swoop in to buy them out, but it was really just my NG bastion while I waited for physical NG to prep for an ultimate rally.

I noted the brilliant NG setup a few weeks ago, which was only waiting for the longer-term charts to catchup before confirming a bullish reversal:

The last shoe-to-drop is the longer-term chart, characterized herein by the weekly, which has indicators building bullishness, but the price just needs to break resistance (having hammered out convincing support just under $4).

Now that we have that confirmation, and I took a position in UNG at $11.20 on Wednesday.

An intelligent investor has to understand that of all the busted-up ETFs out there, UNG is perhaps the worst (save the levered and inverse names). It strays so far from its underlying because of an intense contango in NG futures. The contract roll just erodes NAV. However, I studied the different horsemen of NG exposure (GAZ/UNL), and I found UNG the most appropriate. There’s a lot at work here, so let me explain…

The contango problem in NG, which resonates to UNG, derives from a lack of institutional interest in the front-end of the NG futures curve. In that vein, the near-term contracts trade with great sensitivity to fundamentals, because the trading activity therein comes from hedging and real demand. The earliest instituational & speculative presence can’t be found until way out in 2015+ contracts. That’s due to political feasibility, in the sense that widespread domestic NG commercial/everyday application is pending a minimum two year bureocratic approval process.

Since domestic demand for NG is thus restrained, global demand could provide reprieve. Because the US lacks export facilities, the price of US NG severly lags that of the outer world’s, with supply contrained nations relying on exporters like Russia for their NG (which accounts for over 50% of non-OECD energy needs).

With the combination of our trade deficit and our NG supply glut, I’d expect the US to export to these markets and pounce on the arb spread. But, the US government prohibits the export of oil & gas. Our trade deficit is a product of three outstanding expenditures: energy, war, and entitlements. And frankly, two of those three are attributable to this oil & gas export ban, which was gradually introduced through pieces of legislation throughout the 1970s & 1980s.

The first ban was imposed on Alaskan crude production as part of the legislation opening up new reserves at Prudhoe Bay. Washington gradually expanded the ban over time, ultimately including all onshore/offshore U.S. crude oil & natural gas production. The entire progression was a self-defense reflex in response to the energy crises of the 1970s & 1980s.

The Bureau of Industry & Security (BIS) within the U.S. Department of Commerce (USDOC) enforces the ban under the Export Administration Regulations Commerce Control List (CCL).

When I came across this in March, I was curious because our trade data always reflects a certain amount of energy exports… so how could there be an outright ban? Well, I noticed specific language in the Commerce Control List’s Part 754 “Short Supply Controls” chapter, which establishes an energy export ban as the US modus operandi. However, this chapter allows exceptions to be granted via an application submitted to and approved by the Secretary of Commerce & the White House. Regardless, US law enforces a statuatory net deficit in American energy trade, citing a matter of national security given “short [domestic] supply.”

Enter Cheniere Energy (LNG) on Friday, May 20. From the Financial Times:

The US approved the first exports of large quantities of natural gas through the Gulf of Mexico, a move that could reduce a domestic glut but raise energy costs for its heavy industry…

The government’s assent will allow a unit of Cheniere Energy (LNG) to refit a gas import terminal to condense and ship up to 2.2bn cubic feet a day of domestically produced supply to higher-priced foreign markets. The company’s shares rose 31 per cent.

“With the unprecedented growth in unconventional reserves, supply of natural gas continues to outpace demand dramatically,” said Charif Souki, [Cheniere] chief executive. “…The U.S. has an opportunity to become a significant supplier in the global energy markets.”

The plan, still under review by the Federal Energy Regulatory Commission, is the first authorisation to export natural gas from the continental US to all US trading partners.

As the article mentions, LNG rallied +31% on the announcement. This is big time stuff. Yet, Nat Gas completely faded the news throughout that weekend.

Yea, UNG rides like a busted-up Thunderbird with bumping hydraulics but no air in its tires. It leaps every now and then, but it generally scrapes along rock-bottom. The fundamentals for NG have changed of a sudden, however. The bull case thickens, and more importantly, the bear case dissipates. I always appeal fundamental conclusions to chart readings, because behavioral variables’ reflexive effect on multiples can change the equation. Thus, despite UNG’s 2010 tracking debacle, the chart reads bullish with strong fundamentals like the wind in its sails. Exactly what I like to see.

More importantly, this is an investment I’m making with a long term focus, because it will not lost money over 10 years–never mind 20…


  1. […] had two very profitable rides with long positions in Petrohawk (HK).  Recall an entry from May 26: I rode the Natural Gas ETF (UNG) for its most volatile swings at the end of 2010. After […]

  2. […] know that the arb spread between domestic & foreign hydrocarbons will compress eventually. Previously] $USO $UNG $BNO $GLNG […]

  3. […] the liquefaction facility will have capacity to ship 18M metric tons/year. [See also: US government prohibits hydrocarbon exports] $GLNG […]


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