The price of natural gas has not been this
attractive in 8 years. Some investors are going to make a bundle. I
want you to be one of them.
Today, I’ll show you why natural gas prices
are headed up. And why we can target 43% gains even if they simply get
back to “normal.”
How cheap is natural gas?
Right now, natural gas is selling for $4.58
per MMBTU. (One MMBTU is 10,000 million British thermal units.) That’s
up 80% from its 2009 low. But, as you can see in the chart below, it’s
still 70% off its 2005 high.
So gas is cheap on an absolute
basis. And on a relative basis, it’s a screaming buy.
The relationship between gas and oil
The historical relationship between the
price of crude oil and the price of natural gas is 6 to 12. Why?
Because one barrel of oil produces around six times the energy of one
MMBTU of natural gas. Sometimes it goes as high as 12, because oil can
be refined into gasoline.
Where are we now? Natural gas hasn’t been
this cheap relative to oil in nearly 20 years.
What happens if the ratio
between gas and oil prices simply returns to “normal” – i.e., between
6 and 12? Let’s assume that the price of oil stays the same and do the
math.
Monster gains are possible
Oil is trading at $79 a barrel. Natural gas
is trading at $4.58 per MMBTU.
If the ratio goes to the low end of 12, that
implies a gas price of $6.58 – a gain of 43%!
And if the ratio goes to the high end of 6,
that suggests a gas price of $13.16 – and a gain of 187%!
Some might wonder if the relationship
between gas and oil has permanently decoupled. Not a chance.
It will return to normal. Why? Because when
the price of a commodity falls, consumption rises. Econ 101.
Somebody wants natural gas
With prices this low, one might conclude
that nobody wants natural gas. That’s not true. Some of the smartest
energy people in the country have seen the value and are buying.
Last December, Exxon bought XTO Energy Inc.
It was Exxon’s biggest purchase since they acquired Mobil in 1999. XTO
is the country’s largest natural gas producer. It provides Exxon with
13.9 trillion ft.³ of gas – the equivalent of 2.3 billion barrels of
oil.
In January, Total Oil, another behemoth,
announced a $2.25 billion deal with Chesapeake Energy Corporation (CHK).
Chesapeake is one of the major producers of natural gas in the U.S.
For their $2.25 billion, Total bought a 25% interest in The Barnett
Shale, the largest natural gas producing field in the country.
Exxon and Total are sophisticated
multinational organizations. They can see beyond the headlines. They
know this is what it looks like when you buy low.
Why are gas prices so low?
Too much supply.
The rapid adoption of controversial
horizontal drilling techniques (also known as “fracking”) has
dramatically lowered production costs and boosted gas output.
Patricia Mohr, the Bank of Nova Scotia
economist and commodities specialist, calls fracking a game-changing
technology. Frackers now make up almost half of active drilling rigs
in North America.
As a result of the high flow rates from the
fracked shale fields, the industry has taken steps to curtail
production, as you can see in the chart below.
Three reasons gas prices are headed higher
-
Production will be cut. The number of
active U.S. gas rigs will continue to decline. Fracking has been the
wild card this time around, but the industry will get a handle on
it. And with prices this low, demand for natural gas is sure to
rise.
-
As the hand wringing about global warming
continues, natural gas will be a clear winner. Gas is green. Natural
gas is the cleanest of all the fossil fuels. Compared to coal and
oil, natural gas releases very small amounts of carbon dioxide and
sulfur dioxide. In addition, there is virtually no ash pollution.
-
Fracking will become more regulated and
expensive. That will increase gas prices.
In Delaware, regulators have declared a
moratorium on fracking. New York is considering a similar move. And
Wyoming just introduced some tough new fracking regulations.
Right now, the gas drilling industry enjoys
an exemption that frees it from regulation under the Safe Water
Drinking Act. A bill has been introduced to the House and Senate (the
Fracturing Responsibility and Awareness of Chemicals Act) which, among
other things, would rescind that exemption.
Meanwhile, the EPA is preparing to
investigate the practices of the industry.
The New York Times ran an article
on the fracking debate on Saturday. You can read it
here.
Where to invest
There are a number of ways to play the
coming increase in natural gas prices.
Your first impulse might be to buy a natural
gas ETF like United States Natural Gas Fund (UNG). It has been around
since 2007. I don’t recommend going this route, though. The fund buys
natural gas futures and rolls them monthly – an investing approach
that does not always track the price of natural gas accurately.
Another way to play this market is by using
a royalty trust. These trusts tend to pay very high dividends – but
their assets often include gas fields that are past their peaks, so
revenues (and dividend rates) decline over time. You can learn more
about them
here. A better option is to buy the stock of natural gas
producers. The aforementioned Chesapeake Energy (CHK) is a great play
on natural gas. Southwestern Energy Company (SWN) is another. Both
stocks are dramatically off their 52-week highs.
