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No Bull: Low Natural Gas Prices Offer Great Opportunity

by | published February 1st, 2012

Last Saturday, I had dinner with a friend in Washington, D.C.

She works for a non-profit organization that advocates domestic oil and gas production. (For the record, for every one person advocating energy production in D.C., there are roughly two people pushing back…)

We'd been speaking about Chesapeake Energy's (NYSE: CHK) decision last week to cut its dry gas production, and the impact on the industry. The conversation diverted when she vented, “I don't know why anyone would invest in natural gas since it's gotten so [inexpensive].”

As an analyst, I couldn't ask for a more perfect statement to dissect.

A Popular Misconception

Not only is this view on natural gas incorrect… it allows us opportunity to focus on two important points about energy investing, particularly in the liquefied natural gas (LNG) sector.

  1. First, the price of natural gas will rise again. It's inevitable. And there is plenty of fundamental evidence in other commodity markets as to why. It might not be tomorrow, but it's coming.
  2. Second, and more important, investors, and virtually all Americans, seem so overly focused on the near-term asset performance that they fail to recognize real long-term potential.

Some investors are too impatient to invest in natural gas producers or related field services. Well, fine. To be honest, that is great news for you and me. It's allowing us to get in on these companies while they are still cheap.

We simply need to be patient, given that our long-term outlook is… well… long term.

The Perpetual Glut of Natural Gas

Today the price continues to slump. That's despite the best efforts of companies to contain the overwhelming gas glut at the Henry Hub terminal. In the past few years, we've seen a surge in production thanks to technological innovations like horizontal drilling.

Tack on an abnormally mild winter here in the Continental 48 states…

Mild temperatures have reduced short-term demand, because less fuel has been required to heat American homes. (But I'm sure part of Alaska could use it. It is experiencing record colds over the past three months.)

Put simply, we have an oversupply, and domestic demand has cooled.

And because of that, companies are now taking action.

Noble Energy (NYSE: NBL) and CONSOL Energy (NYSE: CNX) announced they will cut 41 wells from a joint venture's original 140-well shale program in the Northeast.

Meanwhile, ConocoPhillips (NYSE: COP) is shutting down natural gas wells and slashing spending in gas production.

Even Exxon Mobil (NYSE: XOM) , the largest natural gas producer in the country (and it wasn't even in this market three years ago) will slash its output over the next few months.

It seems that my friend's opinion is worth consideration. Perhaps natural gas is too inexpensive, and there's no reason to invest in related services.

Well, I couldn't disagree more. In fact, I'm hoping that this glut leads to more buying opportunities.

All you need to do is look at the price of a steak to understand why.

Meaty Profits for the Bold

I was sitting there in the restaurant, grasping for the best analogy to answer her, only to realize that the answer was literally sitting on the plate in front of me…

I was eating a steak.

And let's just say that the price of 10 ounces of meat is far higher than it used to be.

Beef prices soared more than 10% last year, according to the Department of Agriculture, and they will likely go up at least another 5% this year.

The soaring costs are the result of ongoing droughts in cattle country (Texas and Oklahoma) and the rising cost of feeding animals. But the long-term driver is the ever-increasing total of exports to new markets where customers are beginning to add meat to their diets.

Between 2007 and 2017, Asian demand for meat products will increase from 115 million tons to 149 million, a 30% leap, according to WorldPoultry.net. China's middle class is driving this huge boost. The luxury of a meat-based diet is finally affordable in this region of the world.

We never used to export beef at the rate we do today.

We are witnessing a shift in the market demand curve.

The same thing has happened here with the price of gasoline. The U.S. is currently exporting a record amount of gasoline and petroleum by-products, such as jet fuel. Yet, Americans are still paying very high prices at the pump. Demand for fuels simply isn't going away.

Our ability to export commodities to foreign countries is an underlying driver of these record consumer prices.

And this same phenomenon will be hitting the natural gas markets in just a few years.

So, as the United States begins to export LNG to import facilities around the globe, we're going to see prices of natural gas converge around the globe. As markets open for lower-priced U.S. natural gas, demand for our lower-cost LNG will lead to the balancing of spot prices over time.

This Demand Isn't Going Away

Naturally, voices out there argue that, over time, other countries will gain access to our shale technologies and begin to cultivate their own domestic sources. This argument misses three important points.

  • First, many European countries have outright banned fracking for shale sources. It is unlikely that any of these bans will be overturned in the near term
  • Second, even if certain countries come along and begin to develop their own domestic sources, they still need a great deal of infrastructure (i.e. pipelines, storage facilities, refineries). These projects would take significant investment in multiple cash-strapped regions all around the world.
  • Finally, there's the worldwide push by countries like Switzerland, France, Germany, and Japan to reduce their reliance on nuclear power – in addition to the retirement of coal-fired power plants. This will require a replacement energy source. That fuel is natural gas.

The United States gas producers and exporters are going to experience a growing customer base that isn't accessible today. And when they do, it will be a very profitable time for us.

Here's what to do right now.

Focus on the Midstream

Kent and I talk about the midstream companies all the time.

Again, the “midstream” is where services exist between the fields where the gas is produced (upstream) and the primary processing, treatment, distribution, and sales (downstream). Pipeline companies earn revenue by transporting natural gas from the field to the market.

These midstream companies have been in huge demand over the past few years as upstream gas drillers develop huge new deposits in Pennsylvania, New York, Utah, and other states.

They make their money by charging transport fees. And over the past few years, these fees have remained almost constant, even though natural gas prices have dropped considerably.

But we could see a small retreat in share prices of companies tied to the transport of LNG and shale production if supplies are constricted in the near term.

Take that as a buying opportunity. Pay special attention to companies like Master Limited Partnerships that provide high yields in the double digits and the likelihood of long-term share appreciation.

Over time, as transportation terminals come online and the country begins to export increased levels of natural gas, pipeline companies will be in huge demand to transport fuels all around the country.

And if you don't believe me, I'll bet you a steak.

Sincerely,

James

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  1. February 1st, 2012 at 15:46 | #1

    Great article, thanks

  2. Brent
    February 1st, 2012 at 16:27 | #2

    But what about the argument that the proximity of new gas sources to the traditional usage areas, e.g. New England, means less needs for the long distance gas transmission lines that the mid stream MLP’S operate?

  3. JERE REID
    February 1st, 2012 at 16:51 | #3

    Dr Moors Can you give us a timeline as to when gas will be in such
    great demand? What is long term as you put it for our investments???
    Thank you for your expertise on the gas and oil investments.

  4. Bernard Durey
    February 1st, 2012 at 19:25 | #4

    Well.like the other one stated above. Thanks for your time aqnd expert advice on gas and oil. Now, “What do you think of this?” I read just today that the Missouri Governor approved a 600 mile line from Flanagan,Illinois to Cushing,Oklahoma. That line is a plan of Enbridge,Inc.,which is also one of TransCanadas bitter rivals. However,you still have a TransCanada pipeline,The Keystone,which goes into Illinois,also. So are they going to have to make some kind of mutl agreement or contract,if you will,if that is their plans and where does that transfer at?

  5. ted plottner
    February 2nd, 2012 at 01:13 | #5

    I am starting out with such small amounts to invest—Is it even worth my effort????????

  6. eric taylor
    February 2nd, 2012 at 19:16 | #6

    Fracking the shale is said to put more CO2 in the air, which is said
    to lead to higher temperatures causing a species meltdown. Vertical
    drilling is said to be much cleaner for the environment. Perhaps
    you would like to commit on this subject, if it would not discourage,
    or anger, the many investors who don’t really care one way or the other.
    After all, oil consumption peaked back in the 1990′s(?) on a per-capita
    basis, with some believing we must develop another energy plan for the
    future of the United States.

  7. Kyle Mowbray
    February 3rd, 2012 at 20:35 | #7

    How do you feel about Cheniere (LNG) as a take over candidate at these levels?

  8. Bob Baker
    February 4th, 2012 at 07:02 | #8

    Since Nat Gas prices are at multi year lows, and afecting badly the
    stock of (CHK), will it have a big impact over (CHKR)over the next
    20 Years?

  9. enthusceptic
    February 8th, 2012 at 12:32 | #9

    Please, everyone in North America, Western Europe and elswhere who do more than average mileages with gasoline powered vehicles and get it enabled for gas use! Your bills will decrease, you can get rid of debt and maybe qualify for buying a house!
    One of the main economic news guys on CNN, Mr Velshi, has admitted that he has a “truck” that he doesn’t need. Most city dwellers can get rid of these, including pick-ups, because megastores will deliver when you buy bulk in order to save money. There are many myths about using LNG or LPG to power cars and other vehicles, and many think that they need a “truck” or pick up who don’t.

  10. enthusceptic
    February 10th, 2012 at 06:59 | #10

    …and both up and down stream investments will be great when exports and domestic use of nat. gas take off.

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