Future rises in the cost of natural gas following the recent oil price crash may squeeze utility companies’ profits, with US names potentially proving a lucrative short bet for hedge funds.
Horseman Capital Management, the London-based contrarian long/short manager led by Russell Clark, believes that US power companies – which have steadily shifted from coal to natural gas as a result of cheaper prices since 2008 – may suffer from any imminent reversal.
US natural gas futures, in steady decline since their 2008 high, recently rose following last month’s oil price crash.
But while cheaper natural gas has helped foster a building boom in utilities in recent years, with electricity generation construction particularly strong, profitability could be at risk as a result of a recession and stagnant electricity demand, Clark suggested.
Since the 2008 global financial crisis, US utilities have comfortably outperformed the European sector, despite higher interest rates in the US. Profits have been boosted by US companies increasing their use of natural gas, which has fallen in price since 2008.
In contrast, in Europe – where gas prices have remained higher due to a weaker euro and closer ties to oil prices – utilities have shifted towards renewables, away from both natural gas and coal.
“The problem for US utilities is that the endless growth in US natural gas production looks to be coming to an end,” Clark, whose long-running strategy is renowned for its bearish positions on markets, said in a note this week.
He pointed to falls in production in the Appalachia, a declining rig count, as well as the recent oil price collapse. “Reversing this decline will be very difficult.”
He added: “This change in the natural gas market may explain the sudden weakness in utilities in comparison to government bonds, a relationship that has been in place for more than 10 years.”
“US utilities have been maximising their profits through shifting from coal to gas, but this macro trend looks to be ending. We have probably seen maximum utility.”