Natural gas accounts for approximately one-fourth of the world's energy production. Since it is a much greener source of energy than oil and coal, it is picking up popularity. Natural gas has many uses including heating homes, but the largest percentage is industrial usage. Fertilizer, steel and explosives are just a few examples. By understanding how it is used, an investor would be more effective in predicting natural gas prices. It is also a good guide as to what industries would benefit from lower prices. Lower natural gas prices have helped decrease costs in producing nitrogen fertilizer. The recent drought has hurt the U.S. corn crop (which will be addressed later in this article). Corn requires a significant amount of water and fertilizer. Corn prices have risen significantly over a short period of time, so look for an increased usage of natural gas in preparation for the next corn crop. The big decline in natural gas prices isn't just from increased supplies from unconventional natural gas plays, but also due to poor economics in the U.S. When the economy recovers, we will see the price of natural gas increase. A way to follow industrial usage is through the producer price index (PPI). Being clear, this will not cause the price of natural gas to increase to 2008 levels. I believe we could see prices rise into the $4 range.

The price of natural gas averaged $4 per 1 million Btu (MMBtu) in 2011, but continued to decrease through this year. Since May, the price of natural gas has increased 15% until August, and during this time the price of natural gas increased to over $3. This trade has been volatile. On August 2, we saw the biggest decline in the price of natural gas future since 2009, in an 8% move.

The rebound in natural gas pricing has been the move of drilling rigs from natural gas dominant plays to liquids rich. Supply and demand metrics have brought the price of natural gas down to a point that most of the U.S. plays are not economical. Much of the natural gas produced in the U.S. is a product of unconventional resource plays. This means the majority of this energy source is retrieved in the first five years, with the first year by far being the best. Since these wells deplete quickly compared to vertical wells, production should pull back quickly. In the second quarter of this year, the U.S. natural gas rig count decreased 18% from the first quarter. Since October of 2011, that rig count is down 42%. The rigs moved to liquids rich plays which also produce natural gas. Because of this, we could still see decent amounts of gas being produced. Here are a few liquids rich plays and the percentage of resource produced by it.

Location Oil %
Natural Gas Liquids %
Natural Gas %
Eagle Ford (Oil Window) 78
Bakken (Mountrail) 92
Permian (Wolfcamp) 42
Barnett Combo 41

The Bakken is an exception to this group as the others produce a decent percentage of natural gas and natural gas liquids. Both the Permian and Barnett are combo plays and produce much smaller amounts of oil per well. Obviously the combo plays are not nearly as appealing after the 20% pullback in the price of natural gas liquids, but many are still good enough to keep drilling. Given the current environment in the U.S., I have natural gas averaging $2.95 for the rest of the year. And given the volatile nature of today's pricing we will see big moves. Look for natural gas to average $3.75 in 2013.

Just as WTI differentials to Brent are helping the refiners, a low natural gas price creates the potential for exporting. Natural gas is not a globally traded commodity. As a gas, it takes up too much space to be placed on a ship and sent overseas. Instead pipelines transport gas to Canada and Mexico. If natural gas is cooled to -260 degrees Fahrenheit, it becomes a liquid. In liquid form, it takes up one-six hundredth the space. It can then be loaded on a tanker and shipped to other markets. It takes roughly $3 to $4 for 1 million Btus to convert this gas to liquid and ship it overseas. Overseas, natural gas prices are much higher than in the U.S. In Europe it sells for $12 to $13, and $17 to $20 in Asia. Currently, liquefied natural gas export terminals are being built in the U.S. and Canada. Once these terminals are completed, we will see the price of natural gas in the U.S. increase significantly, and prices abroad will come down. Another variable that could push the price of natural gas up has to do with motorized vehicles, and T. Boone Pickens has been vocal about the positives associated with natural gas powered vehicles. Given the amount of natural gas in the U.S., it would make sense to convert truckload transportation services. To this point it has been difficult in gaining support from the government, but that doesn't mean it will not happen.

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