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Why Producers Aren’t Hedging Natural Gas

Commodities / Natural Gas Oct 30, 2010 - 07:49 AM GMT

By: Keith_Schaefer

Commodities Taking Their Chances in the Spot Market…Later
Natural gas prices in Canada are so low that end users are now trying to seduce producers to hedge, so they can lock in longer term low prices.  But few producers are keen to lock in long term losses.


RBC, Canada’s largest brokerage firm, suggested in a weekly comment that producers still have many reasons to hedge at $3.27 a gigajoule (GJ) now, and $4.11/GJ in April 2011.  For context, the full-cycle cost for new gas in North America is $5.60/mmcf and in Canada is $6.85/mmcf, according to independent analysts Ziff Energy.  So producers would be selling at a significant loss.

But some quick calls to the energy desks of the major Canadian firms showed that few producers are biting, and even one of my contacts at RBC said these “hedging strategies are geared more towards the end-user market; the end users are trying to lock in really good prices. But nobody’s hedging.”

RBC lists several potential reasons for hedging, which often mirror the Ziff Energy white paper from June 2010 on the state of Canadian natural gas (a GREAT read – not too technical – www.ziffenergy.com/download/papers/cdn_gas_crossroads.pdf.)

1.     Strengthening Canadian Dollar
2.     US Production Growth
3.     Reduced Canadian Imports
4.     Heightened Pipeline Delivery Competition in the US
5.     Abundance of Canadian Storage
6.     Material Expansion of Canadian Shale Gas Production
7.     Growth in Marcellus Shale Gas Production – Production has increased by over 1 bcf/d since January 2010

That’s a big list! And it’s not good news for producers or their investors – especially the junior ones who either have high gas weightings or are close to their debt limit.

But despite producers losing money on every mmcf out of the ground, some may be inclined to hedge, says Ralph Glass of AJM Consultants.

“The bigger producers are still drilling and they can afford to (hedge); it’s part of their long term plan and their economics of scale allow it.  The only advantage I can see is that if you’re making positive cash flow at $3.50/mmcf, this gives you stability to hang in for one more year.  But it’s not an investment strategy.”

He added even small producers may consider it: “A small producer that has limited cash flow cannot afford to pay for capacity costs without actually producing the volumes.”  This means they may have “take or pay” like provisions, where the producer must pay the pipeline companies their transportation tolls even if they don’t produce the gas.

For producers, it comes down to the same issue it always does – are prices going lower or higher?  By not hedging, major producers are saying that despite all the gloomy market data, they see prices stable or higher.

Long term dated future gas prices are now below $5/mmcf for a full two years out now.  With such a low, and flat futures pricing curve, producers are saying they would rather take their chances in the spot market then, rather than lock in losses now.

P.S. One of the most-asked questions I get from my readers is, “When should I invest in natural gas?”  Follow the link to read my response. About Oil & Gas Investments Bulletin

Keith Schaefer, Editor and Publisher of Oil & Gas Investments Bulletin, writes on oil and natural gas markets - and stocks - in a simple, easy to read manner. He uses research reports and trade magazines, interviews industry experts and executives to identify trends in the oil and gas industry - and writes about them in a public blog. He then finds investments that make money based on that information. Company information is shared only with Oil & Gas Investments subscribers in the Bulletin - they see what he’s buying, when he buys it, and why.

The Oil & Gas Investments Bulletin subscription service finds, researches and profiles growing oil and gas companies.  The Oil and Gas Investments Bulletin is a completely independent service, written to build subscriber loyalty. Companies do not pay in any way to be profiled. For more information about the Bulletin or to subscribe, please visit: www.oilandgas-investments.com.

Legal Disclaimer: Under no circumstances should any Oil and Gas Investments Bulletin material be construed as an offering of securities or investment advice. Readers should consult with his/her professional investment advisor regarding investments in securities referred to herein. It is our opinion that junior public oil and gas companies should be evaluated as speculative investments. The companies on which we focus are typically smaller, early stage, oil and gas producers. Such companies by nature carry a high level of risk. Keith Schaefer is not a registered investment dealer or advisor. No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer to buy or sell the securities mentioned, or the giving of investment advice. Oil and Gas Investments is a commercial enterprise whose revenue is solely derived from subscription fees. It has been designed to serve as a research portal for subscribers, who must rely on themselves or their investment advisors in determining the suitability of any investment decisions they wish to make. Keith Schaefer does not receive fees directly or indirectly in connection with any comments or opinions expressed in his reports. He bases his investment decisions based on his research, and will state in each instance the shares held by him in each company. The copyright in all material on this site is held or used by permission by us. The contents of this site are provided for informational purposes only and may not, in any form or by any means, be copied or reproduced, summarized, distributed, modified, transmitted, revised or commercially exploited without our prior written permission.

© 2010, Oil & Gas Investments Bulletin

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