Cold-Weather Investing: Coal, Natural-Gas and Heating-Oil Investments Will Pack a Punch in January

[Editor's Note: This Money Morning mainplay report on cold-weather investing strategies focuses on the usual (profitable) suspects - including heating oil, coal and natural gas. But those aren't the only cold-weather investments in town. How about coffee? Or retailers of cold-weather gear? If you'd like to hear more about such "alternative" cold-weather investments, check out the sidebar to this story, which appears elsewhere in today's issue of Money Morning. Just click here to go right to that story.]

By , Contributing Writer, Money Morning •

The irony about cold-weather investing is that the biggest profits come to those who position their money during the hottest months of the year - even during the record heatwave Americans have been experiencing this year.

In short, now's the time to start thinking about such winter-related topics as heating bills, and such cold-weather investments as natural gas, heating oil and coal.

According to the American Petroleum Institute (API), natural gas provides heat for 55% of homes in the United States, followed by electricity, which warms 39%. Heating oil, propane and coal play only minor direct roles, although coal is used to fire 49% of America's electric generating plants, with another 20% fueled by natural gas.

That means natural gas is the natural choice of investors looking for winter-related profits - although Dr. Kent Moors, editor of Oil & Energy Investor newsletter and a frequent contributor to Money Morning, cautions that factors other than routine home-heating demand play a major role in setting prices.

"U.S. natural gas prices will be dependent on two overarching factors in the coming months," Dr. Moors said. "The degree to which industrial demand returns to the market and the severity of the coming winter, which will dictate what kind of supply draw-downs we see."

Investments For a Less-Abominable Snow Outlook

The winter of 2009-2010 was one of the harshest in years (remember "Snowmageddon" and "Snowpocolypse"?). But early forecasts indicate that the winter to come may be much milder.

According to the Climate Forecast System (CFS) - a computer model run by the National Centers for Environmental Protection (NCEP), an arm of the National Oceanic and Atmospheric Administration (NOAA) - we'll see a warmer-than-average December-February period across much of the United States - particularly the country's mid-section. Only Alaska and parts of the U.S. West and Deep South should expect colder-than-normal weather.

He notes that natural gas is used in three primary areas - residential/commercial heating, electricity generation and industrial operations, both directly for power and as a feeder stock for petrochemical production. While demand for heating and electricity generation is back at pre-recession levels, Dr. Moors said that "industrial consumption has yet to return to pre-crisis levels."

Given that reality, Dr. Moors said "there's currently a glut on the U.S. market, which could keep gas prices subdued this winter - probably in the range of $4.50 to $5.00 per 1,000 cubic feet - unless conditions are especially harsh."

(Note: Henry Hub Natural Gas Futures for December delivery were trading around $4.75 on the CME Group's NYMEX energy division last week.)

Given that iffy outlook, Dr. Moors says individual investors seeking natural gas plays should avoid the highly leveraged futures and commodity options, focusing on one of several available exchange-traded funds (ETFs) that track those markets. His two favorites:

  • United States Natural Gas Fund (Nasdaq: UNG), recent price: $7.12: This non-diversified fund is essentially a pure play, investing directly in futures in an effort to track the price performance, net of expenses, of the near-month NYMEX contract.
  • First Trust ISE-Revere Natural Gas Index Fund (Nasdaq: FCG), recent price: $15.63: This fund tracks an underlying index of the same name that follows an equal-weighted portfolio of public companies that derive significant of revenues from exploration and production (E&P) of natural gas. 

One added gas note: You may not want to wait too long to position your plays, since forecasters are still predicting a strong hurricane season in the Gulf of Mexico, the area that accounts for 12% of U.S. natural gas production. If a major gas facility is hit, it could send gas prices quickly higher, erasing the potential for further gains come winter.

Dr. Moors recommends taking an equally cautious approach to heating-oil-related investments, especially since volatility tends to be high this time of year as users try to lock in prices for product delivered several months down the road.

"Prices set now may actually wind up running a bit higher than they will later," he notes, explaining that heating oil prices are driven by both the severity of the weather and the activities of the refiners.

"Low-sulfur-content heating oil, like diesel fuel, is a middle distillate, and if demand for diesel is high, refiners may cut heating oil runs, causing prices to spike."

Dr. Moors expects overall heating oil prices to come in "a bit higher" than last winter, but suggests playing both possibilities. He advises using a "synthetic straddle," which is created by buying two ETFs that track prices of key petroleum products in opposite directions. The expectation is that the gains on one will more than offset any losses on the other, depending on which way oil prices go. The two funds he recommends for this play are:

  • United States Heating Oil Fund (NYSE: UHN), recent price: $24.73: This fund parallels changes in heating oil prices, rising when heating oil goes up and falling when it drops.
  • United States Short Oil Fund (DNO), recent price: $48.00: This fund behaves the opposite of UHN, because it inversely tracks price changes in the near-month crude oil futures contract. In other words, when crude oil prices climb, this fund sees it share price fall, and vice versa.

Cashing in on Coal

Cold weather and coal seem to go together like hot dogs and buns, so it's no surprise that coal is a cold-weather play during nasty winter weather. Dr. Moors thinks coal will be a viable domestic winter play in areas of the country where ample high-grade coal is available for electricity production. But he warns that Congressional discussion regarding a proposed "carbon tax" or new cap-and-trade restrictions could impact prices in a negative manner.
The dominant coal-market factor these days is China, which uses three times as much coal as its U.S. counterpart and that is quickly moving into clean-coal technology. That transition could push prices up as Beijing will have to import large amounts of North American coal - as much as 30% more than last year - since most Chinese coal is of inferior quality and very "dirty" when it burns.

From an investment standpoint, the biggest U.S. beneficiary of China's shift is Peabody Energy Corp. (NYSE: BTU), whose shares were recently trading at $46.55.  The largest U.S. coal producer, Peabody is also buying up reserves in Australia to have a better geographic access to Asia's growing demand.

Peabody expects to sell as much as 260 million tons of coal this year, up from 244 million tons in 2009, all due to increased demand in Asia.  (India is also a big coal importer, with demand there rising 22% from 2009.)

Peabody is already fairly close to its 52-week high of $52.14, so an alternative choice might be one of the new coal ETFs. If you'd prefer a fund to a stock, take a look at Market Vectors-Coal ETF (NYSEArca: KOL), which was recently trading at $33.96.

If you want to place a bet on rising winter power needs, but would rather not dirty up the snow with oil and gas residue, there's also a clean-energy option - the PowerShares WilderHill Clean Energy ETF (NYSE: PBW), recent price: $8.98. This fund tracks the WilderHill Clean Energy Index, which tracks a portfolio of companies focused on green and renewable energy sources and clean-energy technologies.

Actions to Take: If you want to profit on cold-weather investments in January, you have to position your capital now. Heating oil, natural gas and coal offer upside, but investors who want maximum returns need to make their moves as soon as possible.

And not just because cold weather will cause prices to zoom: Forecasters are still predicting a strong hurricane season in the Gulf of Mexico, the area that accounts for 12% of U.S. natural gas production. If a major gas facility is hit, it could send gas prices quickly higher, erasing the potential for further gains come winter.

According to energy-sector expert Dr. Kent Moors, natural gas is one of the best opportunities to pursue. Dr. Moors says individual investors seeking natural gas plays should avoid the highly leveraged futures and commodity options, focusing on one of several available exchange-traded funds (ETFs) that track those markets. His two favorites:

  • United States Natural Gas Fund (Nasdaq: UNG), recent price: $7.12: This non-diversified fund is essentially a pure play, investing directly in futures in an effort to track the price performance, net of expenses, of the near-month NYMEX contract.
  • First Trust ISE-Revere Natural Gas Index Fund (Nasdaq: FCG), recent price: $15.63: This fund tracks an underlying index of the same name that follows an equal-weighted portfolio of public companies that derive significant revenues from exploration and production (E&P) of natural gas. 

[Editor's Note: Dr. Kent Moors, a regular contributor to Money Morning, is the editor of "The Oil & Energy Investor," a newsletter for individual investors. In a career that spans 31 years, Dr. Moors has been consulting the energy industry's biggest players, including six of the world's Top 10 oil companies and the leading natural gas producers throughout Russia, the Caspian Basin, the Persian Gulf and North Africa.

As the preceding story clearly illustrates, Dr. Moors' experiences - as well as the unrivaled industry access, contacts and insights he possesses - are the backbone of the Energy Advantage, an energy-sector advisory service that enables investors to capitalize on his contacts and his global-energy-sector insights. For more information on that service, please click here.]

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Billy
Billy
12 years ago

I am new with investing in stock. I really enjof your report. It gives me a better understanding on what to invest in.

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TB
TB
12 years ago

Dear Dr. Moors,

You said to avoid commodity options. From that, I know you mean to avoid the GLD options. How about options of companies that deal with gold and silver like El Dorado Gold (EGO) or Southern Copper Corp (SCCO) for copper?

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Mike
Mike
12 years ago

You write:
Dr. Moors says individual investors seeking natural gas plays should avoid the highly leveraged futures and commodity options, focusing on one of several available ETFs. His two favorites:
* United States Natural Gas Fund (Nasdaq: UNG) ..
* First Trust ISE-Revere Natural Gas Index Fund (Nasdaq: FCG) ..

When you say "AVOID" and then write "two favorites", it is confusing.
I suppose you mean Favorites of the market to AVOID buying ??

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Isabel marant dress
Isabel marant dress
10 years ago

"misleading"

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