Natural Gas: For Your Future

Colin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

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Though most commodity prices have rebounded since the recession, US Natural Gas prices have remained stubbornly low. This phenomenon is a symptom of a variety of factors--the biggest one being drillers’ newfound ability to tap into America’s vast shale reserves, causing a dramatic increase in supply.

This glut in supply has been harmful to drillers’ profits and share prices. While some companies, such as Encana (NYSE: ECA), have hedges that allow them to sell at prices higher than the market currently offers, these hedges only apply in the short-term and are starting to expire. The situation is far worse for more more highly leveraged, unhedged producers, such as Exco Resources (NYSE: XCO), which have seen even greater decreases in share prices.

Despite the short-term pains that may occur due to low natural gas prices, companies such as Encana, BP (NYSE: BP) and ExxonMobil (NYSE: XOM) have the balance sheets to survive, and will benefit from long-term factors that will grow the natural gas industry in the future.

Aubrey McClendon, CEO of Chesapeake Energy (NYSE: CHK), America’s largest natural gas producer besides Exxon, has made the case that low natural gas prices and an increase in supply will create its own demand. In light of persistently high oil prices, demand for natural gas should increase as it is a substitute. It has become economical for cars and trucks to use natural gas instead of oil, and with proper infrastructure, demand for natural gas should skyrocket. Though it is unlikely that natural gas refuelling stations will be ubiquitous in the near future, companies such as Westport Innovations have been driving demand for natural gas by retrofitting trucks in a way that allows truckers to save money by running on natural gas. 

Liquid Natural Gas shippers and processors have also been profiting as they take advantage of the price disparities between North America and other regions (notably Asia), where natural gas prices are significantly higher. As shipping capacity grows to exploit this opportunity, the demand for North American natural gas should rise, followed by higher prices. The irony is that companies like Westport Innovations and LNG shippers and processors trade at multiples that imply rapid growth, while many producers trade near recession lows.

Ultimately, the aforementioned factors that will cause greater demand for natural gas are symptoms of increasing global fossil-fuel scarcity. This is the underlying reason that natural gas prices (and therefore the underlying assets of natural gas producers) will rise in the long-term.

Though an increase in demand for natural gas will occur in the long-term, buying shares in natural gas producers may not be profitable; over-leveraged companies could dilute shares or go bankrupt in the short-run as they face financial pressures. As such, purchasing high-quality producers now makes sense. Look for companies with low production costs (beware of the way these are accounted for--Chesapeake Energy is notorious for understating its costs), strong balance sheets and reputable managements. Encana and Canadian Natural Resources fit this description--please comment if you can find others.


Fool blogger Colin Tweel owns shares in BP.

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