Now is the Time to Invest in Natural Gas

Nathan Slaughter
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Posted: May 06, 2012 12:01 AM

Since natural gas prices fell of a cliff in 2008, they have continued to descend further and further -- until just recently slipping below $2 per thousand cubic feet (Mcf). Prices have perked up a bit recently, but considering how far it's fallen, it's of little comfort to investors who have tried to catch this falling knife.
 
Gas hasn't been this cheap in 10 years. The peak above $13 per Mcf in 2008 is now a distant memory.


 
Natural gas looked cheap back in January when it was trading around the $2.50 mark. Since then, the commodity tumbled another 20%, with prices really nose-diving below $2.00 in the wake of an unseasonably warm winter before picking back up to near the $2.30 mark.



I've talked about the reasons for this historic drop before in Scarcity & Real Wealth, my monthly advisory. It's no mystery that heavy shale development has unlocked vast quantities of natural gas that have glutted the market. But the blame for this latest downturn belongs mostly to Mother Nature. Natural gas storage facilities typically fill up in the fall, but then draw down in the winter as heating demand rises.
 
But December and January were unusually mild, so fewer homeowners felt the need to crank up the thermostat. That shrunk the withdrawals that are customary in winter, so we entered the spring with a record supply surplus.
 
In fact, there are concerns that the nation's underground storage capacity could be maxed out later this year. As it stands, the latest report from the U.S. Department of Energy shows that natural gas stockpiles rose 28 billion cubic feet in the week ended April 27 to 2.576 trillion cubic feet. For perspective, that's 871 billion cubic feet higher than this time last year and nearly 60% above the five-year average for this time of year.
 
Here's the problem in a nutshell. The amount of natural gas consumed in the United States each year has risen by 12% since 2006. But production has increased at twice that rate, climbing 24%, with output touching 63 billion cubic feet per day last year.
 
That dynamic is slowly starting to change. On the supply side, virtually every energy producer large and small is cutting back or even abandoning dry gas fields and directing drilling and exploration expenditures toward more oil-oriented plays.

Selling gas at $2 per Mcf is a money losing proposition. But there are several reasons to think natural gas prices are about to reverse -- possibly in a dramatic way. Smart investors need to position themselves accordingly.

Gas will still be produced as an oil byproduct. But this industry-wide shift will at least help crimp the supply flow. To speed up the process, Chesapeake Energy (NYSE: CHK) and others are actually curtailing over a billion of cubic feet of gas production per day until prices rebound.
 
But it's the demand side of the equation that could really cause prices to reverse course. Utilities and other industrial users liked natural gas at $5 per Mcf -- at $2, they love it.
 
First, compressed natural gas (CNG) is rapidly gaining traction as a transportation fuel, saving truck owners up to $2 per gallon compared with diesel. This powerful trend is only growing stronger, as evidenced by the 25% gain my subscribers have earned with Clean Energy Fuels (Nasdaq: CLNE).
 
Meanwhile, petrochemical makers such as Dow Chemical (NYSE: DOW) are currently investing billions in plant expansions and new projects to take advantage of cheap natural gas feedstocks. These facilities (which represent the biggest industry spending binge in two decades) will have a hungry appetite for natural gas once they come online.
 
Perhaps most important, natural gas is displacing coal on the power grid. Last year, the Department of Energy forecasted that 90% of all new electricity generating capacity nationwide would be fueled by natural gas. Since then, stringent new government emissions standards have tilted the playing field even more in favor of gas. [See my recent article: "Could this be the Death Knell for Coal Stocks?"]
 
Few ever thought we'd see the day where natural gas was more affordable than cheap Powder River Basin coal from Montana and Wyoming. But here we are. So emission standards aside, basic economics tells us that utilities and other power generators will make the switch and start using inexpensive natural gas to fuel their plants.
 
We may not have seen the bottom yet, but I believe the pendulum will turn later in the year.
 
Beyond that, it's important to remember that natural gas isn't plentiful and cheap everywhere. It's actually quite scarce in Europe and sells for $10 per Mcf. And it's rarer still in Asian markets, where buyers are willing to pay $15 per Mcf.
 
Right now, there is no pathway for U.S. gas to reach higher paying markets. But exports of liquefied natural gas (LNG) are right around the corner. [I own shares of the single best stock to profit from this trend in Scarcity & Real Wealth.]

That will be a game-changer, where if nothing else, arbitrage will cause global prices to converge.
 
Within a few years, billions of cubic feet of gas that would have been used in the U.S. will instead be diverted out of the country, soaking up excess supplies and lifting prices. Meanwhile, the influx of inexpensive shale gas from North America will pour into places such as Japan, easing prices in those markets.
 
Eventually, the pricing gap ($2 here and $10-plus overseas) will narrow, and the two will meet somewhere in the middle. Does that happen at $4 per Mcf? $6 per Mcf?
 
I'm not sure. But I do know that it will lift prices significantly higher than today's moribund levels.

Risks to Consider: As I said earlier, we may have not seen the bottom yet, so there may be some near-term pain you might have to endure if you invest in this sector. But I'm convinced the potential rewards greatly outweigh the risk at this point.
 
Action to Take --> The best time to invest in a commodity is usually when nobody wants to touch it -- and at $2 per Mcf, that is certainly the case with natural gas.

I'm making a big bet on natural gas as the energy source of the future. In Scarcity & Real Wealth, we own shares of toward natural gas producers, pipeline owners, LNG shippers and many others poised to profit from this resource boom. And between 15% and 20% of my personal portfolio is weighted toward these stocks as well. To find out more about my favorite ways to profit from the natural gas boom, I invite you to watch this special presentation.

-- Nathan Slaughter

Nathan Slaughter does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.
This article originally appeared at www.streetauthority.com.