The commodities world goes in cycles, from boom to bust. At times, the price of a commodity falls so low that it cannot be produced cost effectively. Then, the commodity producers will drastically reduce production and eliminate projects. These actions will eventually lead to the particular commodity’s price climbing higher again.
Natural gas has recently gone through the bust phase as its price had fallen 75% over the past few months. However, there are reasons to be optimistic that natural gas prices will head higher. First and foremost, supplies of natural gas are being slashed. The number of natural gas rigs in the US has been slashed nearly in half. Less than a year ago, there were 1,600 rigs in the US pumping out natural gas. Now there are less than 900 rigs in operation, a level last seen five years ago.
Another important factor regarding natural gas is the cost of production. Natural gas production in the US boomed over the past two years due to the development of shale gas. Shale gas is expensive to produce and the production of shale gas will decline much more rapidly than conventional natural gas wells. For shale gas production to be profitable, natural gas prices need to be near $13 per million cubic feet and we are nowhere near that currently.
Another reason for optimism about natural gas prices is the oil to natural gas ratio. In energy equivalent terms, a barrel of oil produces the same amount of energy as six million cubic feet of natural gas. So at its recent low prices, natural gas was selling for approximately only $22 per barrel of oil. The recent price falls in the natural gas were exacerbated by huge short interest positions on the part of traders.
So it was inevitable that natural gas prices would rebound from such an extreme low. Last week, prices staged an impressive 40% rebound. But will that continue? Obviously, there will be some backing and filling, but due to the fundamentals, a bottom for natural gas prices seem to be in place.