These days, energy bulls seem to be placing some risky bets on the weather. Granted, energy stocks may look cheaper than they once did. With energy prices falling from their record peaks, big companies such as Apache ( APA) and Chesapeake ( CHK) now fetch considerably less than they did during the disruptive hurricane season just two short months ago. Even so, some experts say, energy stocks -- and natural gas plays in particular -- could take another hit in the months ahead. "Longtime and long-term bulls on natural gas, as we are, need to look carefully at storage and production levels and the prices in the futures and spot markets," Harry Chernoff, a principal at Pathfinder Capital Advisors, recently cautioned in an article for the trade publication EnergyPulse. "These signs suggest the potential for lower prices in the very near term. ... Only cold weather -- and plenty of it -- can change this situation." With the weather notoriously unpredictable, Chernoff has decided to play it safe. In recent weeks, he has cashed in some of his gains on stocks such as Abraxas ( ABP) and GMX Resources ( GMXR) -- which more than tripled after he first mentioned them in TheStreet.com -- even though he remains upbeat about the long-term prospects for the sector. "If natural gas prices go up several dollars, the stocks will go up, too," he concedes. "But if gas prices go down, the stocks will go down a lot more. ... The risk/reward
scenario is not symmetrical." Abraxas peaked at $9.25 a share in November but has plunged in recent weeks, ending down 5 cents at $6.58 on Thursday. Meanwhile, GMX Resources hit an all-time high of $30 late last month before losing some ground and closing Thursday with a 99-cent gain at $28.60.
A cold spell did in fact hit, he concedes, causing immediate spot prices to rise and close that big gap. But unless winter proves to be especially severe, he says, both spot prices and gas futures will likely come down. "This (recent) narrowing doesn't provide any information about the overall direction of gas prices," he says. "We believe it is more likely that gas prices will decline in the short term -- potentially by 20% to 30% -- relative to oil prices.
And there are several factors behind this belief." Chernoff made that call on Nov. 23 in his article for EnergyPulse. Back then, he noted, spot prices for natural gas were still $2 less than December futures throughout most of North America. For that to happen, he said, a combination of factors -- including ample storage and mild weather -- had to exist. Going forward, he said, only severe winter weather could change the situation. With forecasters predicting otherwise -- except, perhaps, for the eastern third of the country -- Chernoff sees no reason to gamble. "By no means," he says, "do these forecasts imply substantially greater than average weather loads for the country or the gas-dependent markets." In the meantime, Chernoff says, gas storage levels remain ample despite major shut-ins caused by the violent hurricane season. To be fair, he says, mild weather helped dampen energy demand during the fall months. However, he says, cutbacks by major users -- including damaged refineries that help supply the fuel -- played an even bigger role.
In the end, he says, demand has apparently fallen just as much as hurricane-hit supplies. Still, Chernoff says, the market will continue to shape gas prices on the basis of its assumptions about how those supplies will hold up. After all, he has seen it happen before. In 2001, he notes, gas prices more than doubled to $9 in midwinter before falling below their starting point a few months down the road. The same sort of thing happened, he says, the following two years. Interestingly, Chernoff adds, oil prices varied by less than half that amount during those same time periods. "In the current run-up, the same roughly 2:1 dynamic is in place," he says. And "unless the weather loads are substantial enough to maintain the market perception of potential end-of-season shortages, gas prices are vulnerable to a 20% to 30% drop -- even with no changes in oil prices" at all.
Bob Howard, publisher of the investment newsletter Positive Patterns, offers a similar long-term view. Indeed, he feels so bullish on natural gas that he even recommends one major player -- Canada-based Encana ( ECA) -- at today's prices. Notably, Howard says, Encana ranks as the largest natural gas producer in all of North America. Moreover, he adds, the company boasts a strong track record that should continue with all of the opportunities that lie ahead. "Encana has beaten the competition silly in the last 10 years in finding and producing new oil," Howard says. "As many energy companies went slowly and worried about high energy prices sticking -- while the boys on Wall Street said $40-a-barrel would never last -- Encana bravely plowed ahead with new projects that are now paying off in spades. ... So while I am pretty much of the opinion that it is too late to buy many of the energy stocks here, I think Encana is the exception." To be sure, Chernoff counts himself as a long-term energy bull as well. He has simply cut back his energy investments as he waits for better opportunities ahead. And he feels certain those investments -- particularly in the natural gas sector -- will pay off in the end. "North American production is flat or declining while demand is continuing to grow," he explains. "We, as a country, are not doing what makes sense. ... We are just doing what we can" to get by.