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These Natural Gas Stocks Will Bounce Back As Demand Rises

By , Contributing Writer, Money Morning •

Now is the perfect time to invest in natural gas stocks.

To many investors, that may seem counterintuitive. After all, natural gas has been the red-headed stepchild of energy for years.

But prices for this plentiful alternative fuel are just beginning to turn higher after a four-year slide that saw values slashed by more than 80%.

That price decline - from a high of $10.38 per million British thermal units (BTUs) in July 2008 to just $1.83 in April of this year - was primarily the result of a decade-long increase in U.S. gas production, which climbed by 21.6% from 2002 to 2011.

That trend finally has begun to reverse, as the rate of inventory build-up has fallen steadily for almost three months. What's more, the size of the current natural gas surplus relative to year-ago levels has fallen by 23% since late March.

Three big reasons explain this shift:

  • Although the primary use of natural gas is still as fuel for winter heating, more and more electric utilities are switching from coal to the much cleaner gas as fuel for their power plants - and the recent heat wave has spiked that rising summertime demand.
  • We've had an early start to the hurricane season - think late June's Tropical Storm Debby - which has disrupted some offshore production.
  • Some gas producers have finally slowed their output, a reflection of the fact that it makes little sense to keep selling gas at the current price of around $2.87 per million BTUs while the production cost is upward of $4.00 per million BTUs.

Another bullish factor for natural gas stocks in the longer term is the growing drive to find new uses for it. In particular, the U.S. government is aggressively looking for ways to substitute natural gas for dirtier fuels - i.e., coal in power plants and gasoline in cars.

Just last week, the U.S. Department of Energy (DOE) announced $30 million in new funding for 13 research projects dedicated to finding "new ways of harnessing America's abundant natural gas supplies for cars and trucks."

Texas A&M University received a $3 million grant to develop absorbent materials for smaller, low-pressure natural gas tanks (essential if they're to fit in today's passenger cars). And the University of Texas received a $4.3 million grant to design a single-piston natural gas compressor that would make at-home auto-refueling stations more practical.

As reported earlier in Money Morning, rising demand from China and southern Asia - expected to increase by 17% over the next five years - would also bolster natural gas prices and prospects for natural gas companies.

Investing in Natural Gas Companies

The easiest way to participate in the resurgence of natural gas is to purchase shares in one of the exchange-traded funds (ETFs) that focus on oil and gas industry companies. The two purest ETF plays for natural gas are:

United States Natural Gas Fund LP (NYSEArca: UNG), recent price $19.25 - With a market cap of just over $1 billion, this is by far the largest of the natural gas commodity funds. It doesn't invest in natural gas stocks, but uses futures and options to mirror percentage changes in the spot price of natural gas delivered at Henry Hub, LA. The fund's shares have fairly closely followed the recent pattern in gas prices, falling from a high of $46.38 last July to $14.25 in April, then recovering to current levels.

First Trust ISE Revere Natural ETF (NYSEArca: FCG), recent price $15.87 - Smaller than UNG with a market cap of $396 million, FCG tracks an equally weighted equity index of the top 30 public companies deriving most of their revenues from the exploration and production of natural gas. The index is rebalanced quarterly, so FCG's share value doesn't precisely track changes in gas prices and is generally less volatile, having traded in a range from $14.11 to $23.22 over the past year.

For those who prefer a more direct approach to investing in natural gas stocks, two to consider are:

Chesapeake Energy (NYSE: CHK), recent price $18.98 - Among the largest U.S. producers, Oklahoma City-based CHK is one of the purest natural gas stock plays. Its share price has closely tracked gas prices over the past year, falling from $35.75 last July to $13.32 in May. Recently, the controversial activities of CEO Aubrey McClendon have overshadowed the company itself, but Money Morning Global Energy Strategist Dr. Kent Moors says that when McClendon goes, CHK will be "a great business with a long, bright future" - making it a solid buy at current prices.

Cheniere Energy (NYSE: LNG), recent price $15.24 - The major growth in demand for natural gas is in Asia, while the U.S. has a huge surplus. The biggest profit opportunity is therefore the exporting of U.S. gas to the Far East, but the infrastructure isn't yet up to the task. Cheniere, however, has plans to remedy that. It already has the permits needed to build the Sabine Pass LNG export terminal in Texas. Just this week Cheniere received loans for $3.4 billion to fund the project, scheduled for completion by late 2015 or early 2016. As that nears reality, Cheniere should start marching back toward the $40-plus share price it enjoyed in 2007.

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