Natural gas has been described as the ‘fuel of the future’. But it’s not behaving like it.
Prices in the key US market have plunged by 75% in the last four years. And they’re still falling. In 2012 alone, natural gas futures have dropped by 35%.
That’s been welcome news for American consumers. But from an investment point of view, does it mean that natural gas has now become a busted flush?
Far from it. In fact, now is the right time to position your portfolio for a recovery.
Don’t expect natural gas prices to recover soon
No mass energy source is perfect: coal is too messy; nuclear energy is seen as too risky; solar and wind are too expensive.
Natural gas looks like a great long-term alternative to all of these. It’s the cleanest-burning fossil fuel, and it’s non-toxic. All we need to do now is convert our cars and power stations to natural gas, and the planet’s energy problems will be solved.
Not only that, but anyone invested in natural gas would profit handsomely as demand soared along with prices.
Of course, it’s not that simple.
It takes lots of time and money to convert large numbers of vehicles and power plants. And meanwhile, existing natural gas consumers are using less of the fuel.
Last winter was the warmest in the US since 2000, says the National Climatic Data Center. That’s one reason why the US price of natural gas has just hit its lowest point in a decade at around $2 per million British thermal units (MBtus).
But it’s not just down to depressed demand. American gas drillers have been ramping up their output, which has resulted in excess supply. Indeed, US stockpiles are at record levels for the time of year.
“The weather exacerbated the problem”, says J Marshall Adkins at Raymond James & Associates. “But when gas supply is up 8-10% year-on-year, you’re going to have a problem”.
This natural gas glut won’t evaporate in a hurry. Marketed gas production will increase by 4.5% this year, says the US Energy Department. So barring a freak cold spell, there’s limited chance of the US natural gas price picking up much in the near future.
Understandably, the shares of many natural gas producers have been clobbered along with the gas price. So should we just forget about investing in natural gas for the moment?
Natural gas is an obvious choice for ‘fuel of the future’
The short answer is no, we shouldn’t. I won’t try to predict exactly when the price of natural gas will bottom out, but I do believe in the long-term case for the fuel – and that the price will eventually recover sharply.
The potential supply is huge, and that makes natural gas a clear frontrunner in the race to be ‘fuel of the future’.
The discovery of vast reserves of shale gas under North America is a game changer for the US. This January, President Obama claimed that the US now has 100 years of natural gas supply. A few people have since queried his maths, but whatever the precise truth, there’s still plenty to be going on with.
The UK may soon join the party. Two weeks ago the British Geological Survey said that UK offshore reserves of shale gas – ie natural gas extracted from shale rock formations – could exceed one thousand trillion cubic feet (tcf).
That compares with Britain’s current gas consumption rate of 3.5 tcf a year. Even if only 10-20% of total reserves are currently recoverable, the UK should still become energy self-sufficient. With our oil running out, that’s got to be good news. And with our North Sea oil production expertise, Britain is well placed for offshore shale gas extraction.
Sure, there’s been some controversy about the technique used to extract natural gas. Hydraulic fracturing, or ‘fracking’, involves pumping pressurised water, sand and chemicals underground to open fissures and to improve the flow of oil and gas to the surface. This has led to concerns about chemicals escaping into water sources.
But a recent University of Texas study says that there’s no direct link between groundwater contamination and the fracking process. And this month, a UK government report once again backed onshore shale gas drilling after a temporary fracking ban.
How to profit from natural gas
If the potential future supply of natural gas is this large, then why will prices recover? Because the future potential demand is even larger. The US Energy Information Administration forecasts that by 2035, 80% of all America’s new electricity generation capacity will come from natural gas-fired power plants.
That alone looks a good reason for being bullish on natural gas. But the real story lies outside the US. Natural gas prices around the rest of the world are much higher – $11.5/MBtu in Spain, $13.65/Mbtu in India and $16.65/Mbtu in Japan.
So as soon as it can build enough facilities, America will export much more of its natural gas glut to meet global demand.
Further, the smart money is now moving into the sector. Australian oil and gas firm Aurora is run by some clever operators, and it’s looking to snap up shale deals while gas prices are in the doldrums.
“We expect gas prices to remain subdued through this year and next year”, says Aurora’s boss, Jon Stewart. “But it’s unsustainable for gas prices to remain as low as they presently are, because there’s little if any incentive for companies to drill gas wells”.
So what stocks should you buy?
Aurora has risen far too much – it’s up 3,000% in the last three years. But a natural gas transporter seems a good idea. In November 2010 we tipped LNG (liquefied natural gas) carrier Golar (Nasdaq: GLNG). The stock subsequently trebled, but it’s since dropped back. On a forecast price/earnings (p/e) ratio of 12 for next year, this may still have some mileage.
And recently, my colleague Phil Oakley reviewed one of the biggest US natural gas producers, Chesapeake Energy (NYSE: CHK). I’ll warn you now – it’s a controversial stock, and not one for the faint-hearted. But it’s well worth checking out what Phil has to say. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
Category: Investing in Technology