This commodity is indeed a gamble against mother nature. This year, somehow, summer is not as hot as it needs to be. While it is warmer than usual, it is not warmer than the 5 year average.
Nevertheless, this week we will see California and Arizona suffering from a scorching heat wave that might lead to record breaking high temperature. This might help revive hopes of a bullish rally.
The fundamental reason behind my natural gas gamble is due to a few reasons which I would like to list down again.
1. Natural gas rig count has been declining and is now hovering at 350, much lower than the peak at above 1,000. This week's rig count showed a slight increase but horizontal gas rig continued its decline. This means that we will be seeing production decline really soon.
2. It is uneconomic to drill for natural gas at this level. While many of the marcellus operator claims IRR of 20% at $3.50, this is unproven as the shale area has only been in existence for 4 years. The Marcellus wells have extremely high decline rates. A suggested break even level is $5 - 6 as noted by industry experts in my earlier posts.
3. Nat gas demand has been rising as industrial activity picks up in the US. More coal plants have been decommissioned permanently and is substituted with natural gas plants. The coal-to-gas switching will be permanent by 2016
4. Obama's support for natural gas and impending export of the commodity in 2016
5. Increased export to Mexico with 7.0bcf capacity by 2014 vs ~3.5bcf today
6. Easy-to-drill wells have been exploited, leaving the harder ones behind which might lead to higher drilling cost in future
All in all, we will see a decline in production very soon while demand continue to rise. This is a great set up for a natural gas spike just as it has happened several times in the course of its trading history. This will be a report of the 2001 natural gas spike.
I see $6 as a potential target by December and $8 as an optimistic target.
I suggest to long UNG and UGAZ. I have positions in these ETF as of this writing.