HOUSTON -- Remember when then-president Jimmy Carter told us during the energy crisis of the 1970s that the U.S. would exhaust its natural gas supplies by 1991?  That turned out to be just as wrong as Al Gore’s global warming predictions of a few years ago will be.   

It just goes to show that technology and necessity are powerful partners.  It is never a good long-term idea to bet against the pair.   

Beginning in the 1990s and accelerating through this decade the oil and gas industry, driven largely by a few relatively small independents, developed new methods of finding and delivering enormous quantities of natural gas. 

Horizontal drilling and new fracturing technology has allowed producers to access ancient deposits of hydrocarbons and natural gas from rocks that used to be uneconomic. 

Recent estimates show that with the new technology, North America has at least ten decades worth of natural gas reserves already proven, with more on the way from big new fields once thought too “tight” to produce. 

So, technology and mankind’s relentless quest to improve the human condition (and to improve the innovator’s financial condition!) have found ways to solve our collective energy needs, at least in the field of natural gas.  We feel the same thing is true for just about all other human needs over time.

Pond scum to the rescue?

With China, India and much of the underdeveloped world on an upward sloping standard-of-living curve, there will likely be even stronger demand for natural resources in the near future and that is a big part of the necessity-side of the equation.  Enter technology and cue the innovators. 

Presently, smart, ambitious researchers and scientists are making important progress in relieving the world’s “addiction” to oil as well.  

By the way, we are not really “addicted” to oil; we just use the heck out of it right now because it’s one of the cheapest alternatives for energy needs.  By the time our grandkids are our age that might not be the case at all.  We might well have gone through several new technological breakthroughs by then just as we have with natural gas since the Carter “years of sacrifice” and “misery indexes.”     

There is no denying that ancient deposits of oil are limited.  It is after all just one planet.  It’s not like we can go and mine another planet or an asteroid, yet.  But when human necessity and human’s ability to solve problems are not held back too much by idiotic and parasitic governments new things happen and solutions bubble to the top.  The collective demand for energy will almost certainly drive new solutions to sate our insatiable appetite for it so long as innovators are rewarded for their time, risk taking and ingenuity. 

One promising and under-reported example of such demand-based innovation is currently focused on one of the plants which likely contributed to ancient petrocarbon deposits – algae.  That’s right, the green goop which clogs lakes.   Keep an eye on the amazing new field of making bio-diesel … literally from pond scum.  We expect to have more about this, much more, in future reports because with big energy giants like B.P., Exxon, Chevron and Shell pouring hundreds of millions of dollars into ultra-green friendly pond scum research, it just might herald a new day in the “energy patch.”   

We humans are now on the cusp of being able to “grow oil” and make it a “renewable resource.”  What a fabulous concept. 

Please note:  Gold Newsletter (GNL) subscribers received this issue of the Got Gold Report Monday, August 3. GNL subscribers enjoy access to all Got Gold Reports, technical charts, analysis and information, as well as Brien Lundin’s timely and actionable analysis of specific resource related companies.  For more information or to subscribe visit the Gold Newsletter home page.       

Back to natural gas, Houston, we have conflicting signals…       

On Thursday, July 30, the EIA reported an injection into storage of 71 billion cubic feet (71 bcf), in line with expectations but slightly above the 15-year average.  This, during a much milder than normal July.  (Surprise!  Apparently folks who worship at the Church of Global Warming are having their faith assaulted this year.)  How much cooler? 

 
The above climate map was “borrowed” from the EIA website.  Much of the U.S. was below average and as measured in heating/cooling days, the figures are surprising as shown in the table below. 

Global warning, baby it’s cold outside 

All but two reporting regions reported lower cooling degree days for the week ending July 23.  Yes, it really was cooler than normal.  Our question should be, with all those CDD minus signs and so many analysts telling us that NatGas is being over-produced, how could the NG injection only be about average?  Shouldn't it have been a lot more?  More like 90 bcf or even over 100 bcf? 

Instead the NG injection into storage was more like normal.  We think that suggests that production is already coming in, but will the decline in production be enough, fast enough to put a floor under NatGas prices anytime soon?     

The current amount of NatGas in storage is about 3.02 trillion cubic feet (tcf) which is about 19% above the EIA’s reported five-year average of 2.5 tcf for this time of year.  The 15-year average injection for August - November (the remaining injection season) is about 790 bcf more which means that if conditions remain near normal the storage could reach as high as 3.8 tcf before the injection season ends.  That’s very high. 

For those who are following the action, below are the 15-year average injections into storage for the month of August.
 
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Looking ahead, the average injection for the first week of August has been 53 bcf.  Last year, even with all the new gas wells on line the injection was 56 bcf in the first week of August.  

With storage facilities bulging, unless we see significant declines in production, we could be heading for an all-time record in storage.  By itself that bodes ill for NatGas, but maybe there are other factors at work which will affect production just ahead. 

For example, reported production cuts announced by Chesapeake last quarter were actually not taken, perhaps because they were not answered by others in the industry.  Now Chesapeake says they intend to really make those production cuts.  (Is CHK more like OPEC when it comes to production cuts?) 

Producers may have to curtail production from existing wells out of necessity anyway as some storage facilities and pipelines are nearing their theoretical limits and new storage facilities planned in Louisiana are being delayed or scrapped.  We might actually be heading for LOWER than average weekly injections into storage due to capacity constraints.

CFTC rushing to close the “speculator” barn door, post facto  

It seems that bearish news for NatGas is coming out of the woodwork even as the anti-investor CFTC is forcing the largest NatGas ETF to reduce its exposure to the regulated futures markets on NYMEX and ICE. 

The United States Natural Gas Fund (NYSE: UNG, Stock Forum) may even have to close the fund to new shares because the SEC has not yet approved its application to increase the number of shares it can sell.  Even if the SEC approves UNG’s request, UNG management announced last week that it may choose not to expand the fund anymore because of the regulatory onslaught against it. 

Traders say part of the weakness in last week’s NG market is attributable to UNG offloading both ICE and NYMEX contracts in favor of less regulated, but more difficult to manage “bilateral total return natural gas swaps” negotiated with very large, well-funded investment-grade counterparties (Goldman Sachs and JP Morgan among them no doubt).

How ironic.  Because the CFTC now apparently intends to remove the exemptions from position limits in futures contracts, exemptions commodity pools need in order to do their thing, those funds and pools will haul off to less regulated and less transparent markets wherever they can.  That is easy to do with the global and very liquid oil market, but less easy to do with the largely North American-centric natural gas market.       

The CFTC, under power-hungry chairman Gary Gensler, seems incapable of understanding that the ETFs are not “speculators,” themselves, but instead represent the funds of hundreds of thousands of individuals and money managers.  They represent people like us who seek to protect the buying power of their wealth -- ordinary investors seeking protection from our run-away spending government which continues to destroy the purchasing power of our now totally fiat currency.

Insanely, some politicos and regulators have bought into the idea that energy ETFs are a “cause” of higher prices at the very moment when natural gas is at a seven-year low in price.  It’s yet another “kick the dog while it’s down” power move, isn’t it, Chairman Gensler?  

Along those lines, we hope that folks will review some of the testimony given in the CFTC hearings on futures limits this past week.  The testimony of Dr. Henry Jarecki of Gresham Investment Management is on our “required reading” list.  Among other important things, Dr. Jarecki said,  following a litany of reasons why index funds and commodity pools are not responsible for high energy prices: 

“I appreciate, however, that the idea that commodity futures purchasers cause high physical market prices is superficially appealing.  And I accept that the Commission may, in response to public concern, decide that something should be done.  Ut aliquid fiat, we used to say when I practiced medicine: “In order that something be done.”  When the relatives were pushy and asked us to do more, we gave large and very colorful pills.  Ut aliquid fiat videatur: “In order that it be seen that something is being done.”

Bravo for Dr. Jarecki, who apparently has enough of the proverbial round spheres to very publicly call a spade exactly what it is in this case.  Dr. Jarecki sat right there and looked across and up to the members on the CFTC and boldly told the world that what they were contemplating is the equivalent of a placebo in medicine.  Bravo for you if you read the rest of his testimony (linked above) and share it with others.     

Interested investors can watch the CFTC hearings via archived webcasts at this link:  http://capitolconnection.gmu.edu/cftc/webcastarchive.htm

NatGas is getting less “rigged” 

The debate and the perverse actions by regulators will undoubtedly rage on over the short term and while the CFTC has energy ETFs in their gun sights, out of an abundance of caution, we have largely rolled out of the UNG fund and into royalty trusts instead.  Trusts like Permian Basin Royalty Trust (NYSE: PBT, Stock Forum) and San Juan Basin Royalty Trust (NYSE: SJT, Stock Forum), which we mentioned in previous reports, will have to take the lead role in our NatGas play for now. (Full disclosure: We still hold some UNG in several accounts but intend to exit opportunistically this week or next.)    

You know, all this comical Congressional and regulator scapegoating and finger pointing is unsettling if one is invested in the markets.   However, it’s funny how a market, the press and people will seize on just one side of an idea for a while. 

We are all aware that NG drillers can now produce from these new tight gas zones using horizontal drilling.  “They can produce gas from rocks with the porosity of hardened concrete,” we hear…  Yeah, that’s not far off the mark, but people don’t know or forget that those wells are expensive to drill and they also forget how quickly they come down in production once they come on line.            

Take a look at this chart of the onshore rig utilization rate (ORUR) published Thursday, July 30, by the EIA.  We think it is extremely important. 

The ORUR has fallen off a cliff since last year, but we continue to hear from overly bearish analysts that “the horizontal rig rate hasn’t fallen as much!”  That’s true, by the way, the number of horizontal drilling rigs has “only” fallen about 40%, THAT’S FORTY PERCENT, but what we don’t hear is that some of the reason for that is because they take longer to drill and complete than vertical rigs.  Some of those horizontal rigs still working this past week were “spudded” back when the memory of $6 NatGas was still very fresh.     

George Mitchell, now in his nineties but still going strong, said last week that natural gas had to be over $4 for most horizontal wells in shale deposits, on average, to make economic sense.   With natural gas now under $3.50 at the Henry Hub, shouldn’t we think it is now more likely that we will see additional reductions in the horizontal portion of the ORUR decline?   (Even if not, a 40% reduction is not exactly a small thing.)     

Larger companies think so.  In a TV interview Friday, July 31, Chevron’s V.P. for exploration George Kirkland said, “By the end of the year we will not have a single gas land rig running.”  If Chevron won’t be drilling; if Chesapeake actually does make the production cuts it says it plans to make (and if other companies follow suit this time), it shouldn’t be all that long before we see production of natural gas failing to match the 15-year averages. 

Natural gas is cheap energy by any measure  

And that brings us back to the original thesis for our natural gas play.  One tenant of that thesis is that just as “high prices are the cure for high prices,” so then are “low prices the cure for low prices.” 

Currently the contango has been blown out by UNG’s ungraceful exit from some of their ICE and NYMEX futures (and traders gaming that).  The September-January spread ballooned all the way out to an extreme $1.99 between the contracts, an unsustainable contango very short term, no pun intended. 

We believe, however, the chaos and confusion being caused by CFTC intervention into the futures markets will be, uh.. “short” lived and sooner or later (probably sooner) the NatGas market will settle down and begin to discount more the actual market forces and less government meddling. 

The bottom line is that no matter how much this CFTC wants to muck up the NatGas frog pond, over time the commodity will do what it has always done in response to market forces – it will discount them well in advance.  Kind of like it did in the last big NatGas bear in 2001-2002.  (See the 10-year chart just below.)     

Head for the Big Easy

Before moving into the conclusion section just a quick aside to say I’m looking forward to presenting and meeting some of you at the always exciting and stimulating New Orleans Investment Conference to be held this year at the Hilton New Orleans Riverside October 8-11.  It will be here before we know it!   

The New Orleans conference has always boasted an impressive speaker lineup, but this year conference organizer Brien Lundin has outdone even himself with a power-packed menu of experts and savvy intellectuals in both business and politics.  Including Dr. Marc Faber...Dennis Gartman...Peter Schiff...Dr. Stephen Leeb...Doug Casey...Rick Rule...Adrian Day...Frank Holmes...Bob Hoye...Bob Prechter...Dr. Mark Skousen...Ian McAvity...Pam and Mary Anne Aden...Brent Cook...David Coffin...Lawrence Roulston…Thom Calandra…Rick Santelli…Carl Rove…Howard Dean and many, many more. 

As of right now there are still spaces available, but they are going fast.  For more information or to reserve for the conference please use this special link and send me an email note if you plan to attend so we can connect there.  It should be fun, interesting, entertaining and very worthwhile. 

Summing up: The bottom line for this report is that while we would love not to have to think about the heavy hand of government messing with the “free” markets, the facts say otherwise and rather than get caught in that crossfire we have elected to switch vehicles for the most part until the CFTC is done giving the voters Dr. Jarecki’s “bright colored pills.” 

While we cannot know how far down natural gas will ultimately go before it inevitably heads much higher and we cannot know if it has already plumbed its ultimate lows for this cycle, we believe that with each passing day now the effects of a lower rig count and quickly falling production profiles on new tight wells will almost certainly begin to show up in the production figures.  Indeed we are a little surprised they haven’t already, but we have to remember that this has been one of the coolest summers in many years so far.

Some things are simple to measure and understand. 

We know, for example, that natural gas is at an extremely low price compared to oil as shown in the chart just below.   That doesn’t mean that the ratio can’t get even wider, but the current divergence in price between oil and NatGas is out of bounds historically speaking.  NatGas is extremely cheap relative to oil.  

Could this ratio go out even more?  Sure, you bet it could if oil blasts though upper resistance in the $70 region and NatGas falls even further, but sooner or later this ratio will mean revert just as oil has already done relative to gold.  (See the chart just below for evidence.) 

We know that compared to gold, real money, the price of NatGas is at an extreme divergence from the norm as shown in the chart just below.  Natural Gas is extremely cheap compared to gold metal.  The ratio has not been this wide for 14 years. 

With natural gas so undeniably cheap compared to most any benchmark one wants to compare it to and with oil having already recovered, it isn’t all that surprising that the companies that produce natural gas have already been discounting higher NatGas prices as shown in the graph just below.  The graph tracks the $XNG ratio compared to the price of NatGas itself. 

One of our jobs as investors (Chairman Gensler calls us “speculators”) is to identify imbalances and opportunities in the markets and to then get positioned in those markets in order to profit as the markets return to their historic norms (or at least correct the imbalances). 
 
We think the current NatGas market is a market which is unbalanced to the downside and although we have not yet seen clear evidence that it is correcting, we believe that day is close enough to begin positioning for it.  The NatGas producers are already trading as though it has.   

We plan to continue to add to our NG positioning opportunistically, in small measured incremental units in natural gas royalty trusts and other vehicles.  As much as we might have liked to continue to employ the NatGas ETFs, as long as the “governistas” continue to scapegoat them as the “reason” for higher prices, other NatGas vehicles have to take the “point” for now.

That’s all from Houston this week.  Until next time, good “Vulture Bargain Hunting” with Brien Lundin’s hot-off-the-press issue of Gold Newsletter, good trading and, as always, MIND YOUR STOPS. 

The above contains opinion and commentary of the author.  Each person should study the issues carefully and, as always, make their own informed decisions. Disclosure:  The author and/or his family currently holds a net long position in SPDR Gold Shares, net long COMEX silver futures, net long iShares Silver Trust, net long natural gas ETF UNG, long San Juan Basin Royalty Trust (SJT), long Permian Basin Royalty Trust (PBT), long the following “Vulture Bargain Hunter Stocks” mentioned in this report or within the last three months: Timberline Resources (TLR), Paragon Minerals (PGR.V), Forum Uranium (FDC.V), Odyssey Resources (ODX.V), Radius Gold (RDU.V), Columbus Gold (CGT.V), Endeavour Financial (EDV.T), Terraco Gold (TEN.V), Bravo Venture (BVG.V), long SDS as a Big Market hedge and currently holds various (approximately 25) other long and short positions in mining and exploration companies. The author receives no compensation from any company mentioned in this report.  To contact Gene use LLCCMAN (at) AOL (dotcom).

Read more Stockhouse articles by Gen Arensberg