With natural gas prices hitting new lows, many investors have been tempted to bottom-pick the market as most natural gas producers have seen their shares lose an incredible amount of value.
For example, Encana Corporation (TSX:ECA)(NYSE:ECA) is Canada’s top natural gas company by volume, with about 2,350 million cubic feet of production per day. Over the past 12 months, its shares are down over 60%. Peyto Exploration & Development Corp. (TSX:PEY) is a smaller firm, producing roughly 400 million cubic feet per day. Its shares are down over 20% in the same period.
Despite what may look like attractive deals, there are reasons to believe natural gas prices could stay depressed for an extended period of time, creating nothing but value destruction for most natural gas producers.
The U.S. continues to pump
Plenty of analysts are calling for a halt in natural gas price declines due to lower prices, arguing that this should discourage further supply gains, while adding new demand growth. The data proves otherwise.
Baker Hughes Incorporated estimates that the amount of natural gas rigs in North America is at a decade low. But despite the rig count falling dramatically, companies have a large amount of wells in inventory that are ready to resume drilling should prices begin a recovery. This means that while supply gains may be slowed, they are ready to come back on to suppress any price recoveries.
For example, many U.S. states report having thousands of wells that are waiting to produce. One company, Chesapeake Energy Corporation, reports having 275 million cubic feet per day of production that is currently curtailed and awaiting completion. Investors predicting an end to today’s oversupplied natural gas market may have to wait awhile before that actually comes true.
Demand can’t keep up with supply gains
While bulls were expecting demand to ramp up given incredibly viable natural gas prices, this simply hasn’t happened. The U.S. consumes roughly 105 billion cubic feet per day at peak demand, while Canadian demand stands at less than 10 billion cubic feet per day. This means that in terms of influencing natural gas prices, the U.S. takes the lead.
Unfortunately, demand will not only experience lower growth than expected, it could actually fall. The U.S. Energy Information Administration anticipates domestic natural gas demand to fall for the residential and commercial sectors. Only a small bump in industrial demand will keep overall consumption from falling.
This will result in 2015 peak consumption to peak at around 100 billion cubic feet per day compared with the last two years of 105 billion cubic feet per day.
Any way you look at it, prices should remain low
This should be a textbook case of simple economics. The market remains oversupplied, while demand growth is tepid at best. All of this should result in continued low natural gas prices. Given that this led to the precipitous decline in natural gas stocks, don’t expect any sustained rebound in shares of producers such as Encana Corporation or Peyto Exploration & Development Corp.
