How To Play The Prolonged Bull Run In Natural Gas

Since the Russian invasion of Ukraine last month, a lot has been said and written in the U.S. about the impact of that and the subsequent sanctions on the price of oil. From a media perspective, that makes sense because Americans have an abiding interest in the price of gasoline. The sheer size of the country and its relative wealth mean that Americans drive a lot, and that wealth combined with relatively low fuel prices means that they often drive trucks and other vehicles that are far from fuel efficient. In that situation, gas at over $4 per gallon is big news, so oil over $100/barrel is too.

However, far less coverage is given to price moves in another commodity, natural gas, that has also strengthened on the war in Ukraine and the response to it and that in some ways has a more wide-reaching impact on the economy than oil. In 2021, according to the official Energy Information Administration (EIA) figures, natural gas powered plants accounted for 38.3% of electricity generation in America, making it by far the most important fuel source for power generation. Yes, oil prices impact a lot of goods because of transportation costs etc., but just about everything we do in the modern world consumes electricity, so a big jump in the price of a key resource in that area should probably be bigger news than it is.

In part, the lack of media attention on natty is probably because, as the 10-year chart above shows, extreme volatility in the market is nothing new. Spikes in price are quite common but are almost always followed by rapid retracements. The question is, is this going to be another of those times?

The circumstances suggest maybe not.

First, while Russia is an important supplier to the global oil market, their supply to the natural gas market is far more influential, in Europe if not in the States. So far, Germany and other nations dependent on Russian gas haven't found a way to wean themselves off it. But, with Putin's insistence this week that they pay for what they use in Rubles, they may have too soon if they aren't to make a mockery of their own sanctions policy. That will leave a big supply gap, and imports, including from America will have to fill it.

That is good news for investors in a stock like Cheniere Energy (NYSE: LNG) who are in the business of liquefaction and export of U.S. gas, but it also means added demand for domestic output. Unlike with oil, though, temporary disruptions in the balance between the supply of and demand for natural gas can't be addressed by the stroke of a White House pen. There is no strategic natural gas reserve, so restoring the balance is left to market forces and, ironically, the President's action on oil will make that process less efficient.

This week's move by the Biden administration to release a million barrels a day from the strategic petroleum reserve is designed to ease the pressure on crude prices, but it will also serve to discourage energy companies from upping their oil output in the immediate future. Around 20% of U.S. natural gas comes from what are primarily oil wells and, while that is not a massive percentage, it is significant enough at the margins for artificially restricted supply to make a difference.

Of course, none of that really matters if the war in Ukraine ends quickly, but Putin's seemingly delusional view of both how Ukraine sees Russia and how the war is going combined with the ferocity and bravery of the Ukrainian resistance makes that look unlikely.

So, this move up in natty looks like one that can be sustained, but what does that mean for traders and investors? And what is the best way to play it?

I am talking here in the long term, and more about prices remaining at high levels than surging much higher. That doesn't mean there won't be volatility at those higher levels, so futures trading in one direction is not the best play. Stocks like the aforementioned LNG and other natural gas-dependent companies like Chesapeake Energy (NASDAQ: CHK) are a better bet. They will continue to benefit from elevated gas prices compared to the norms of the last few years, even if there is two-way movement, so those two would be my choices.

It is fair to assume that eventually the market will do its thing, and that higher natural gas prices in America will lead to increased production, bringing prices back down. However, a fundamental shift in global supply conditions and short-term measures aimed at oil prices will delay that and make stock in natural gas companies a decent play for a while. So, as the headlines around oil continue, don't forget about the opportunities in natty!