As Prices Rise, Here's How to Play Natural Gas Companies

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The price of natural gas hit a 10-year low in April, sinking to $1.91 per MMBtu on April 19. Since then, natural gas prices are on the rise. In fact, prices have surged nearly 50%, to around $2.75 per MMBtu over the past four months.

What changed?

One, the sector came out of a very mild winter that saw very poor demand for natural gas.

Two, the onset of summer – and a particularly hot one, at that – has had the exact opposite effect.

This summer's record-setting heat has wreaked serious havoc on the economy. The price of everything we consume has been to some degree impacted by the heat, and natural gas is no exception. As temperatures have risen, utility companies have had to rely more and more on natural gas to generate electricity.

What's more, due to strengthened environmental regulations, coal-fired power plants are coming off-line, and their capacity is being replaced by natural gas.

On the supply side, prices were also juiced by last week's Energy Information Administration report that supplies increased by 24 billion cubic feet, missing expectations of a rise between 27 million bcf and 31 million bcf.

While prices are up, they're still hovering below $3. Since much of the country is still in the throes one of the hottest summers on record, there's still some money to be made.

What's more, analysts are predicting a colder winter than last year, which should bring some stability to prices when the heat wave subsides.

Investing in Natural Gas Companies

Since natural gas prices are coming off some pretty historic lows, it makes sense to proceed with caution.

One way to do this is to invest in companies with exposure to both oil and gas, companies that can adjust production to meet demand and the ever-changing expectations of the market.

Here are three to consider.

Apache Corp. (NYSE:APA) is a Texas-based independent oil and gas producer with exploration and production interests in the Gulf of Mexico, Canada, Egypt, Australia, Argentina, and the United Kingdom's North Sea. As of December 2010, the company's proved reserves totaled 2.95 billion barrels of oil equivalent, roughly 50% oil and 50% natural gas.

In the past few years, management has proven its commitment to growth by making several key acquisitions.

In 2010, the company acquired Mariner Energy for $2.7 billion, and bought $7 billion worth of assets from BP plc (NYSE: BP) to help the latter company pay for the Deepwater Horizon Oil Spill.

In 2012, Apache acquired Cordillera Energy Partners for $2.5 billion in cash and 6.3 million shares of common stock, adding an estimated 71.5 million boe to its reserves.

Apache's second-quarter earnings came in at 0.86 per share, well below analyst expectations of $2.53 per share, and even further below the $3.17 it managed in the same period in 2011, despite record production of 774,000 boe per day. This is largely due to those rock-bottom natural gas prices, as well as the falling price of oil in the second quarter.

Apache's market cap is hovering just under $35 billion, and it has a P/E of 10.57. The stock has a one-year target price of $113.42, which is nearly 30% above where it's currently trading. If oil and gas continue to rise, that's a fairly easy target to hit.

Chesapeake Energy Corp. (NYSE: CHK) has been through some difficult times lately, thanks to the antics of CEO and former board chairman Aubrey McClendon (he's been removed as board chairman but soldiers on as CEO).

Late last year, Chesapeake shed most of its derivatives positions, selling the hedges that would protect it against fluctuations in natural-gas futures prices.

At the same time, the company increased its oil production to take advantage of relatively higher prices. Chesapeake continues to increase its liquids production, aiming for an increase of 70% year over year, all the way to 250,000 bbls per day in 2015.

This is an ambitious plan. But the increase in oil production is going to subsidize the production of natural gas as oil continues to rally.

What's more, the company intends to sell nearly $14 billion in assets to help trim its $14.3 billion in long-term debt.

McClendon is still a wild card, but he's no longer running the board, and he's being checked by some new blood, including investor Carl Icahn, who now owns 7.5% of the company.

While Chesapeake is known as the second-largest natural gas producer, it should become much more profitable as it shifts some of its production to liquids, and a lot leaner when it erases some of that debt from its balance sheet.

If natural gas prices continue to rise as well, then the company will do even better. Chesapeake has been beat up lately, but the stock is up 4.5% in August.

Natural Gas Stocks: Risk Management is Key

Another way to safely invest in natural gas stocks is to pick a company with a well-tested risk management strategy.

LINN Energy LLC (NasdaqGS:LINE) is one of the largest independent exploration and production companies in the U.S. As of December 31, 2011, the company boasts approximately 5.1 Tcfe of proved reserves in producing U.S. basins.

Management has proven savvy when it comes to hedging the company's production.

LINE is 100% hedged on expected natural gas production for six years through 2017, and 100% hedged on expected oil production for five years through 2016. For 2012, the company is hedged at a weighted average oil price of $97.26 per barrel and a weighted average natural gas price of $5.28 per Mcf.

The company is committed to growth. To that end, LINE has made three recent acquisitions totaling $2.4 billion, including the Jonah Field properties in Wyoming's Green River Basin for $1.025 billion, and the Kansas Hugoton field for $1.2 billion. Last year alone, the company completed 12 different asset purchases.

Management recognizes that, while its best-in-the-industry hedges limit downside, they also squander some upside potential. So the company entices investors with an impressive yield of 7.4%.

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