Topic: Energy Stocks

Commodity investments: Stalking a natural-gas price bottom

The price of natural gas has fallen to around $2.50 U.S. per thousand cubic feet, a seven-year low.

The price decline has been driven by lower industry demand during the recession. As well, consumers have cut their air-conditioner use because of cooler-than-normal summer weather in central Canada and the northeastern U.S.

Another major factor is a buildup in gas inventories, to the point that the North American industry is running out of storage. According to the U.S. Energy Information Administration (EIA), natural-gas inventories are at 3.204 trillion cubic feet. That’s 21.3% higher than a year ago.

At the same time, producers have been using new techniques, such as horizontal drilling, to extract more gas from shale deposits. Imports of liquefied natural gas have also boosted supplies.

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Take natural gas price predictions with a grain of salt

The low price of gas has touched off a fresh round of speculation in the media about whether or not it has reached a bottom. However, gas prices, like oil prices and many other commodity investments, will remain highly volatile. That’s why we think it’s a bad idea to base investment decisions on predictions of future oil and gas prices, because these predictions are simply not reliable.

In light of low gas prices, we updated one of the commodity investments we’ve followed for some time, natural-gas producer EnCana Corp. (symbol ECA on Toronto), in a recent Successful Investor Hotline.

EnCana is a leading North American producer of natural gas and oil. Gas accounts for about 80% of this commodity investment’s production.

In response to falling prices, the company has cut its gas production by 10%, and is putting off investments in new projects until prices rise again.

But it has gained an advantage with its hedging contracts, through which it has locked in two-thirds of its production through October 31 at an average of $9.13 U.S. per thousand cubic feet. That’s on top of the 45% of its output that it has hedged through October 2010 at $6.09 U.S. per thousand cubic feet.

Like other natural-gas producers, EnCana needs higher gas prices to show significantly improved revenue and cash flow. But over the longer term, the company should gain from its focus on what it calls “key resource plays.” These are unconventional properties, such as early-stage gas fields and oil-sands projects, that have much longer production lives than conventional properties. We’ll continue to update the company’s progress on this front in our Successful Investor newsletters and Hotlines.

Don’t overindulge on resource and commodity investments

One crucial rule: if people generally believe the price of a commodity is sure to go up, the reverse often happens. That’s because both suppliers and users of the commodity also read the newspapers, and they both take steps to protect themselves and profit from the situation. The suppliers try to increase supplies, and the users try to become more efficient or find alternative commodities. This tends to expand supply and weaken demand.

Rather than trying to predict a gas-price bottom, we think you should include resource and commodity investments (this, of course, includes oil and gas) in your portfolio – but in reasonable amounts — around 20% of the total or so. That way, you stand to gain if your commodity investments rise, but you won’t be hurt too badly if they drop.