No Bull: Low Natural Gas Prices Offer Great Opportunity


"As the U.S. begins to export LNG to import facilities around the globe, we're going to see prices of natural gas converge around the globe. As markets open for lower-priced U.S. natural gas, demand for our lower-cost LNG will lead to the balancing of spot prices over time."

Last Saturday, I had dinner with a friend in Washington, D.C.

She works for a nonprofit organization that advocates domestic oil and gas production. (For the record, for every one person advocating energy production in D.C., there are roughly two people pushing back. . .)

We'd been speaking about Chesapeake Energy's (NYSE:CHK) decision last week to cut its dry gas production, and the impact on the industry. The conversation diverted when she vented, "I don't know why anyone would invest in natural gas since it's gotten so [inexpensive]."

As an analyst, I couldn't ask for a more perfect statement to dissect.

A Popular Misconception

Not only is this view on natural gas incorrect. . .it allows us opportunity to focus on two important points about energy investing, particularly in the liquefied natural gas (LNG) sector.
  1. First, the price of natural gas will rise again. It's inevitable. And there is plenty of fundamental evidence in other commodity markets as to why. It might not be tomorrow, but it's coming.

  2. Second, and more important, investors, and virtually all Americans, seem so overly focused on the near-term asset performance that they fail to recognize real long-term potential.

Some investors are too impatient to invest in natural gas producers or related field services. Well, fine. To be honest, that is great news for you and me. It's allowing us to get in on these companies while they are still cheap.

We simply need to be patient, given that our long-term outlook is. . .well. . .long term.

The Perpetual Glut of Natural Gas

Today, the price continues to slump. That's despite the best efforts of companies to contain the overwhelming gas glut at the Henry Hub terminal. In the past few years, we've seen a surge in production thanks to technological innovations like horizontal drilling.

Tack on an abnormally mild winter here in the continental 48 states. . .

Mild temperatures have reduced short-term demand, because less fuel has been required to heat American homes. (But I'm sure part of Alaska could use it. It is experiencing record colds over the past three months.)

Put simply, we have an oversupply, and domestic demand has cooled.

And because of that, companies are now taking action.

Noble Energy (NYSE:NBL) and CONSOL Energy (NYSE:CNX) announced they will cut 41 wells from a joint venture's original 140-well shale program in the Northeast.

Meanwhile, ConocoPhillips (NYSE:COP) is shutting down natural gas wells and slashing spending in gas production.

Even Exxon Mobil (NYSE:XOM), the largest natural gas producer in the country (and it wasn't even in this market three years ago), will slash its output over the next few months.

It seems that my friend's opinion is worth consideration. Perhaps natural gas is too inexpensive, and there's no reason to invest in related services.

Well, I couldn't disagree more. In fact, I'm hoping that this glut leads to more buying opportunities.

All you need to do is look at the price of a steak to understand why.

Meaty Profits for the Bold

I was sitting there in the restaurant, grasping for the best analogy to answer her, only to realize that the answer was literally sitting on the plate in front of me. . .

I was eating a steak.

And let's just say that the price of 10 ounces of meat is far higher than it used to be.

Beef prices soared more than 10% last year, according to the Department of Agriculture, and they will likely go up at least another 5% this year.

The soaring costs are the result of ongoing droughts in cattle country (Texas and Oklahoma), and the rising cost of feeding animals. But the long-term driver is the ever-increasing total of exports to new markets where customers are beginning to add meat to their diets.

Between 2007 and 2017, Asian demand for meat products will increase from 115 million (M) tons to 149M, a 30% leap, according to China's middle class is driving this huge boost. The luxury of a meat-based diet is finally affordable in this region of the world.

We never used to export beef at the rate we do today.

We are witnessing a shift in the market demand curve.

The same thing has happened here with the price of gasoline. The U.S. is currently exporting a record amount of gasoline and petroleum byproducts, such as jet fuel. Yet, Americans are still paying very high prices at the pump. Demand for fuels simply isn't going away.

Our ability to export commodities to foreign countries is an underlying driver of these record consumer prices.

And this same phenomenon will be hitting the natural gas markets in just a few years.

So, as the United States begins to export LNG to import facilities around the globe, we're going to see prices of natural gas converge around the globe. As markets open for lower-priced U.S. natural gas, demand for our lower-cost LNG will lead to the balancing of spot prices over time.

This Demand Isn't Going Away

Naturally, voices out there argue that, over time, other countries will gain access to our shale technologies and begin to cultivate their own domestic sources. This argument misses three important points.

  • First, many European countries have outright banned fracking for shale sources. It is unlikely that any of these bans will be overturned in the near term

  • Second, even if certain countries come along and begin to develop their own domestic sources, they still need a great deal of infrastructure (i.e., pipelines, storage facilities, refineries). These projects would take significant investment in multiple cash-strapped regions all around the world.

  • Finally, there's the worldwide push by countries like Switzerland, France, Germany and Japan to reduce their reliance on nuclear power—in addition to the retirement of coal-fired power plants. This will require a replacement energy source. That fuel is natural gas.

The United States gas producers and exporters are going to experience a growing customer base that isn't accessible today. And when they do, it will be a very profitable time for us.

Here's what to do right now.

Focus on the Midstream

Kent Moors and I talk about the midstream companies all the time.

Again, the "midstream" is where services exist between the fields where the gas is produced (upstream) and the primary processing, treatment, distribution and sales (downstream). Pipeline companies earn revenue by transporting natural gas from the field to the market.

These midstream companies have been in huge demand over the past few years as upstream gas drillers develop huge new deposits in Pennsylvania, New York, Utah and other states.

They make their money by charging transport fees. And over the past few years, these fees have remained almost constant, even though natural gas prices have dropped considerably.

But we could see a small retreat in share prices of companies tied to the transport of LNG and shale production if supplies are constricted in the near term.

Take that as a buying opportunity. Pay special attention to companies like master limited partnerships that provide high yields in the double digits and the likelihood of long-term share appreciation.

Over time, as transportation terminals come online and the country begins to export increased levels of natural gas, pipeline companies will be in huge demand to transport fuels all around the country.

And if you don't believe me, I'll bet you a steak.

Sincerely, James

James Baldwin, Oil & Energy Investor

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