With natural gas prices plummeting to as low as $2 a unit, now appears to be a great time to take the other side of the trade and get long. Steadily increasing supply and warm winter weather have severely depressed natural gas, prompting many producers to cease production due to lack of profitability. And therein lies the opportunity for investors to take the contrarian approach; the market usually fixes the problem on its own.
As the country's top E&P companies shut-in production due to low prices, the market figures out a way to bring supply and demand more into balance. Inventories deplete and prices begin to firm up as excess supply abates. In the low $2 range, it seems like a strong bet that the worst of the natural gas price decline is behind us.
On the demand side, the United States still has yet to fully embrace our rich natural gas reserves as an alternative transportation fuel, but we are making strides in the right direction. Take a look at the lofty expansion plans of Clean Energy Fuels (NASDAQ: CLNE), a big player in converting long-haul trucks and public transportion vehicles from gasoline to natural gas, and you will see what I am talking about.
From an investment standpoint, the easiest way to play a rebound in natural gas is through the exchange traded fund, United States Natural Gas Fund (NYSE: UNG). At just over $5 per share, it appears to be a bargain for longer term investors willing to be patient with a contrarian long idea.
For those worried about a continued decline, or the issue that UNG often loses some correlation with the underlying natural gas price due to its reliance on using futures contracts, consider writing covered calls against your long position to provide income and hedge yourself. The January 2013 $5 calls trade for over $1 each, so you can hedge 20% of your downside completely and still capture a nice double-digit return if natural gas prices stabilize or rebound over the next year or so.
Overall, in a market that looks a bit toppy, natural gas offers longer term contrarian investors an intriguing value opportunity in my view.
Disclosure: I am long UNG.
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