It's going to be a good winter for natural gas and the companies that drill for it, Morgan Stanley says

Key Points
  • Low prices for natural gas should increase demand for the commodity at power plants, Morgan Stanley said in a research note.
  • Gas prices could rise above current market expectations under normal weather conditions.
  • Morgan Stanley upgraded Cabot Oil and Gas against this backdrop.
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Natural gas-focused drillers stand to benefit as low prices appear poised to drive up demand for the commodity, according to .

Prices for future delivery of natural gas have fallen below $3 per million British thermal units. That sets up a more attractive backdrop for natural gas producers as low prices give power plants a reason to burn natural gas rather than coal.

"Natural gas forwards have now fallen to levels in-line with (or below) our bearish sub-$3 forecast, driving a more constructive risk-reward into winter 2018," Devin McDermott lead U.S. gas and power commodity strategist at Morgan Stanley said in a research note on Tuesday.

Under normal weather conditions, Morgan Stanley forecasts natural gas prices could rebound to $3.25 to $3.30 per mmBtu in the fourth quarter of this year and first three months of 2018. That compares with prices just above $3 per mmBtu in the forward curve, which reflects what the market is willing to pay in the future.

The bank believes investing in drillers with low cost structures and excellent balance sheets like Cabot Oil and Gas is the best way to play the more attractive risk-reward outlook this winter. It recently upgraded Cabot to overweight.

But Morgan Stanley maintains its long-term bearish outlook on natural gas and is underweight other drillers like Gulfport Energy and Southwestern Energy.

Natural gas-fired electricity generation exceeded coal-fired power in the United States for the first time last year. But power plants are burning more coal than natural gas this year because gas prices are above last year's levels.

Morgan Stanley expects some plants to switch over to natural gas in the August to October period, creating additional demand for about a half billion cubic feet per day of gas.

WATCH: Nat gas inventories up 17 billion cubic feet

Natural gas inventories up 17 billion cubic feet
Natural gas inventories up 17 billion cubic feet