Three Pressing Energy Investing Questions, Answered

Dr. Kent Moors

Given the action that has taken place in the sector over the past several months, I haven't had the opportunity to sit down and answer your many energy investing questions.

So let's do that today.

Your questions have focused mostly on three issues, and I've put them all together and answered them.

First, many of you have asked about the status of liquefied natural gas (LNG) exports from the United States and how that will impact the global market.

One promising company in particular has drawn your interest…

Energy Investing Question No. 1: How Will U.S. LNG Exports Affect the Global Market?

Cheniere Energy Inc. (NYSEMKT: LNG) was to have begun exports in the fourth quarter of last year from the Sabine Pass facility on the Gulf of Mexico, but that has now been delayed until the first quarter of 2016. The company has secured five major 20-year contracts with some of the largest European and Asian LNG importers in the world.

In addition, the U.S. government has approved several other terminals and company export applications. With the acceleration of LNG trade worldwide, U.S. exports are expected to account for 6% or more of total volume before 2020 (from 0% now).

However, it will take some time for LNG sales to establish sufficient hold in some markets. That's because the initial delivery price will exceed that for natural gas coming via traditional pipeline.

Nonetheless, LNG will be one of the most important changes in the energy sector over the next decade.

This importance comes from the ability to establish spot markets in every location where regular volume is delivered. This ability to trade locally in short-term contracts will undermine the position (and price) of long-term pipeline delivery contracts.

As with just about anything else, increasing trade and guarantee of delivery will lower the export price and improve the predictability of local market transactions. And that will have a primary ripple effect across energy usage in entire economies.

Question No. 2: What Are ETFs and ETNs, and How Should I Use Them?

Second, many of you have been asking questions about whether exchange-traded funds (ETFs) and exchange-traded notes (ETNs) trade like any other stock on the secondary market…

Now, while these instruments look similar, there is an important difference.

When you invest in an ETF, you are investing into a fund that holds the asset it tracks. That asset may be stocks, bonds, gold or other commodities, or futures contracts. On the other hand, an ETN acts like a fixed instrument (a bond). It's an unsecured debt note issued by an institution.

Just like with a bond, an ETN can be held to maturity, or bought or sold at will. But if the underwriter (usually a bank) goes belly up, the investor would risk a total default.

Both have been popular as a way to tap into wide areas of the energy sector. Remember, an ETF or ETN will have management fees. While they usually track a particular index and attempt to reflect the movement of the underlying assets, the actual return to the investor results from how well the ETF or ETN actually tracks the underlying assets and how big the fees are.

Using an ETF or ETN does allow you to "track" a large market segment without committing significant investment exposure. That may be useful in the current continuing volatility in energy, especially in oil.

Some of you have also asked about "bear" and "bull" ETFs and ETNs. These attempt to magnify the return, with the more liquid providing two ("2x") or three ("3x") times the actual movement of underlying assets. A "bear" ETF or ETN gives positive returns when the underlying value goes down, while a "bull" does the opposite.

If the instrument in question is a direct play on a commodity value – the price of oil being the most popular these days – a significant return can be had in a short period of time during intense price movements…

Provided you get the direction correct.

If not, remember this. Your loss from one of these will amount to two or three times the movement of the underlying asset (depending on the specific ETF or ETN). So, if you are betting on a decline in oil prices and the price actually rises, your loss will be about 200% to 300% of the rise in oil.

In other words, it is very important to note the much higher risk involved with using these leveraged or "multiplier" ETFs or ETNs.

Question No. 3: What Will Happen with America's Smaller Oil Companies?

Finally, the question asked more than any other is how smaller oil and natural gas producers in the United States are likely to fare in the current climate.

Not well, is the short version of the answer.

Sustainable per-barrel prices of at least $10 higher than what is now in the market are required if most of these small guys are going to survive much longer. They are almost all heavily indebted, and their only access to additional credit is now experiencing a significant deterioration in interest rates. At levels approaching (or surpassing) 18%, the cost is too prohibitive.

A rise in bankruptcies, along with a new round of mergers and acquisitions, is inevitable. Some smaller companies may survive by selling selected assets, but such cherry picking will help only a few.

Some of you have asked whether Congress lifting the ban on oil exports will help these smaller companies.

Unfortunately, the rise in U.S. exports will not come quickly enough, nor at an adequate price, to be of help here. And while the recently announced oil production "freeze" will likely establish a floor for oil prices, the bounce will not happen quickly enough to be of much difference.

Make no mistake. Oil prices will be rising. My estimate remains $42 to $45 per barrel by June.

But this is not going to stem the coming tide of "creative destruction" in the oil and gas sector.

When the dust settles, you will have some choice plays. But in the interim, keep your powder dry.

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Dr. Kent Moors

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Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.

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