Investment Opportunities in Natural Gas

In this week’s Energy Trends Insider our featured stories were The Navy’s Biofuels Program and the Great Green Fleet, Investment Opportunities in Natural Gas, and the Short Term Oil Price Investment Outlook. As we did last week, we would like to share one of those stories with regular readers of this column. Interested readers can find more information on the newsletter and subscribe at Energy Trends Insider.

The following story is exactly as it appeared in Energy Trends Insider, except the name of a company that was discussed in the newsletter has been omitted since this column is aimed at a more general audience.

Investment Opportunities in Natural Gas

By: Robert Rapier

Advances in hydraulic fracturing have opened up new supplies of natural gas in the U.S. and reversed its fortunes. Just a few years ago natural gas was widely believed to be on the verge of a permanent production decline in the U.S. Now, shale gas is making a major contribution to U.S. gas supplies, and based on recent prices there is certainly a widespread belief that the U.S. has ample supplies natural gas. Some believe that it’s only a matter of time before gas prices spike again. Prices spiked above $10 per million BTU in 2005 and again in 2008. Similar spikes were seen in 2000 and 2003.

However, investors should not expect prices to spike in the next few years. Today natural gas is trading below $3/MMBTU, and the prospects are good that the price will remain depressed. Some producers are shutting in production due to low prices, anddrilling activity in the Marcellus Shale is declining due to low prices. In the short term this should help firm up prices, but this production will be brought back online if the price creeps back up to $5 or $6 per MMBTU. Therefore, I see natural gas trading in a range from around current prices with a small downside (Henry Hub is $2.87/MMBTU as I write this) up to perhaps $6/MMBTU.

As an investor, direct investments into companies producing natural gas may not provide attractive returns. On the other hand, there are companies that will benefit from low natural gas prices. I believe those companies will primarily be utilities that are switching from coal to natural gas, and companies that facilitate an increase in natural gas penetration into the transportation market by producing vehicles that run on natural gas, providing services to convert natural gas vehicles, and/or build out natural gas infrastructure.

One example of a company in this space is XXX (company name has been removed; if you are an investor in this space it isn’t difficult to figure out the company). They design, build, operate and maintain fueling stations, supply customers with compressed natural gas fuel (not necessarily the most lucrative part of the business), sell equipment used to maintain and operate natural gas filling stations, and convert light and medium duty vehicles to run on natural gas.

Expiration of a tax credit at the end of 2011 has adversely affected earnings so far this year, and the share price has been volatile. Year to date the share price has appreciated by 16%, but it had nearly doubled this year before recently pulling back. The company sports a current market capitalization of $1.25 billion. A bet on this company is a bet that natural gas prices will remain depressed and that fleet owners will move in greater numbers toward natural gas – which presently trades at about 1/10th the cost of diesel on an energy equivalent basis.

For fleet owners, the economics of switching to natural gas are very attractive, even if natural gas prices climbed to $7/MMBTU. At current prices, a barrel of oil would have to be priced below $20 to be as cheap on an energy equivalent basis as natural gas. Oil is not going to be sustained at $20 again, and natural gas is likely to be a cheaper energy option than oil for years to come.

While some believe that supplies of natural gas are grossly overstated, my own belief is that the U.S. will be in a good supply position with respect to natural gas for a number of years. Thus, I believe companies involved in the buildout of natural gas infrastructure have better than average long-term growth prospects. However, if you are invested in companies that are dependent upon high natural gas prices to survive — you may want to reconsider those investments.