And All that Gas

By Robert Zimmerman - August 21, 2012 | Tickers: CMI, EEP, F, HMC, WPRT | 0 Comments

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No question, there is money to be made in natural gas.  The US Energy Information Administration (USEIA) reports that the United States imports over four billion barrels of oil a year.  Of the top 15 countries that export oil to the US, most don't like us.  Our number one supplier is Canada, and after the controversial US-Canadian women's soccer game played during the recent Olympics, I'm not sure the Canadians like us, either. Since 2006, oil imports have declined slightly and the trend is for further decline.  The recession certainly has played a role in that decline but the rise in natural gas consumption in the US over the same time likely contributed, too.  Since 2006, US natural gas consumption has increased more than 10%.  At the same time, natural gas imports, for example from Canada and Mexico, have declined.

One of the driving forces behind the increase in natural gas use is the increase in domestic production, in particular production from shale via hydraulic fracturing ("fracking").  As the chart below shows, while natural gas production in the Gulf of Mexico has declined since 2001 and is projected to continue declining, gas production from shale has risen and should continue to do so.

This trend away from oil and to natural gas is good news for the US.  For years we've heard warnings about our dependency on foreign oil and how our foreign policy and economy are vulnerable to upheavals in the Middle East.  With a transition to natural gas, national energy supply is increasingly domestic and with that, increased jobs and tax revenue.  The threat of oil shocks as experienced in the 1970's aren't as intimidating.  For consumers, the rise in natural gas production has led to a decline in price.  Slowly, more vehicles, particularly fleet vehicles, are running on natural gas.  By one industry estimate, 3% of all natural gas is burned in vehicles.  Lastly, utilities generating electricity with natural gas has been credited by the USEIA with a decline of CO2 emissions in the US. 

So how do investors make money on all this?

Obviously, there are the natural gas producers themselves.  Chesapeake Energy and Noble Energy are two considerations. Both stocks have come off their 52-week highs, CHK, ahem, particularly so.  Another play, more for income perhaps than capital gains, is Enbridge Energy Partners (NYSE: EEP).  This company engages in "natural gas gathering, treating, processing, transportation and marketing assets in the United States" and as a limited partnership currently pays a 7.3% dividend.  With a PEG of 3.89, EEP is a tad expensive but is down about 12% from its 52-week high.  If natural gas continues its domestic production and consumption trends, EEP could benefit significantly.

A different angle is the natural gas vehicle industry.  On the one hand, Honda (NYSE: HMC) produces a natural gas burning Civic that starts at around $26,300 and is now available in 35 states.  Sales volume so far has been almost non-existent.  However, with an expanded sales region and more options available for the car, Honda reportedly hopes to sell 2,000 natural gas cars this year.  Honda also makes the fuel cell vehicle Clarity that uses hydrogen from natural gas, but this car will be available only for lease on a very limited basis primarily in southern California.   Don't even get me started on the availability of natural gas fueling stations. So, yes, there is growing interest in natural gas cars,  but I'm doubtful they will have a large impact on Honda's overall earnings anytime soon. 

On the other hand, there is Westport Innovations (NASDAQ: WPRT).  This company bills itself as a leader in natural gas engines for all manner of vehicles.  They have collaborated with Cummins (NYSE: CMI) to develop heavy duty engines for trucks.  They also make engines for passenger cars, locomotives, forklifts and buses.  Their main customers seem to own fleet vehicles, making the natural gas fueling station problem a bit smaller.   For the three months ended June 30, they doubled the volume of Cummins engines shipped from the previous year.  Westport also reports a gross margin of 38%.  Any downside to this company?  Well, they aren't making any profits.  EPS has been negative since 2009 at least.  The stock is off its 52-week high, but well above its low, too.  However, recent losses have narrowed, the company is active in China, they signed deals with General Motors and Caterpillar and project a 50% growth rate.  That is, the company has positive momentum.  I would exercise both interest and patience with this investment.

Looking back at the chart of US natural gas production, the blue wedge labeled "shale gas" should read "opportunity" for investors. A growing stable domestic energy product for a stronger economy and cleaner environment - a winning investment if you ask me.

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