Oil, copper, steel, gold and other industrial and precious metals tend to garner most of the attention in the credit markets when talking about the commodity complex. Rightly so, as they serve as proxies for global gross domestic product (GDP) growth, flight to quality/risk sentiment and Chinese demand.
Natural gas, on the other hand, sometimes gets lost in the shuffle despite having a more prominent role in the credit markets. This is due to its direct and indirect impact on a large and diverse set of companies in the investment-grade and high yield indices. Natural gas serves as an important feedstock for chemical companies, is a price setter for electricity wholesalers and is drilled, processed, transported and sold by midstream and upstream energy firms.
The exploitation of shale gas and the rise in production began before the 2008 financial crisis but the impact really began to be felt subsequent to 2011. The unprecedented amount of cheap new supply and the ability to transport it caused prices to plummet, eerily foreshadowing the future rout in oil prices. After bottoming in early 2016, gas prices have staged a nice recovery, up about 20% year-to-date.
While the demand story for natural gas is positive via increasing gas-fired generation, accelerating liquefied natural gas (LNG) exports and overall industrial demand, the supply situation remains problematic. Breakeven costs for the most efficient gas producers are well below $3.00/BTU (British thermal unit) and supply has continued largely unabated. Inventories are still heavy, rig counts are going up and oil production may start to increase again if oil stays over $50. The latter is an issue because a byproduct of oil production is associated natural gas, which exacerbates the supply issue.Key takeaway:
Absent a very cold winter, I am concerned the rally in prices may fade, particularly as weather is a swing factor in natural gas prices and sentiment as it is still largely a domestic market. While the securities of natural gas companies tend to trade cheap on a relative basis, I am more conservatively positioned in shorted dated bonds and modestly levered bank loan paper.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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