What Happens When Natural Gas Prices Rise?
Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Natural gas isn't as cheap as it was a year ago and that's leading to big changes in the energy market. That will be a good thing for Ultra Petroleum (NYSE: UPL), Royal Dutch Shell (NYSE: RDS-B), and Alliance Natural Resource Partners (NASDAQ: ARLP).
Drilling for natural gas costs money. How much varies by company, but Ultra Petroleum pegs the average cost at about $7, with a high of around $10 and a low of $3. Ultra, is among the lowest-cost producers. However, with natural gas trading in the $4 range, a lot of drillers aren't making money.
So, while natural gas prices have increased notably off of their lows in the $2 range, they still aren't high enough for the natural gas industry to see big profits. A company like Ultra, however, is benefiting now from rising prices.
Ultra's revenues and earnings jump around, like most commodity focused companies. And 2012 was a particularly ugly year because a $2.9 billion non-cash write-down of its gas properties led to a loss of more than $14 a share. That write-down, however, is likely to be reversed in the future as natural gas prices recover, and it didn't affect the company's underlying business.
As natural gas prices rise, look for Ultra to be among the first in line to benefit. The shares offer aggressive investors notable upside potential.
Another company set to benefit from rising natural gas prices is Royal Dutch Shell. Shell was among the big players to invest heavily in U.S. natural gas assets as gas prices headed to their highs. That investment quickly turned into a notable problem when prices fell to historic lows.
This investment, coupled with troubles finding new sources of oil, has been a notable drag on the stock. For example, despite their very similar makeups, ExxonMobil and Chevron are both afforded premium prices compared to Shell. In fact, Shell's around 5.3% yield is nearly twice that of Exxon and about two percentage points higher than Chevron.
All three of the integrated oil giants see their top and bottom lines jump around a lot. However, like the other two, Shell has a solid history of regular, though not annual, dividend hikes. Moreover, it is financially strong and offers investors a way to play a gas rebound without the need to invest in a company almost totally dependent on natural gas.
The In-Between Number
With an average break-even price of $7, natural gas drillers are going to have a tough go of it. That's because high gas prices generally lead electric utilities to switch from gas to cheaper coal. For example, BP's annual energy review highlighted that natural gas consumption grew in the United States in 2012, but fell in Europe.
The reason is that natural gas is more expensive in the Old World. However, that trend is one that investors need to watch closely. For example, Peabody Energy reported that through the first four months of the year, natural gas use by utilities declined 14% and coal use increased 11%. The rise in natural gas prices was the reason, as utilities switched to the lowest cost fuel source to protect profit margins.
So, companies like Peabody and Alliance Natural Resource Partners will also benefit from increasing gas prices. Alliance, however, is particularly well positioned. Almost all of its coal comes from Northern Appalachia and the Illinois Basin, two areas that produce coal competitive with natural gas, priced as low as $3.
For more aggressive investors willing to get involved in a totally unloved natural resource, Alliance is a good option for playing rising gas prices. Despite a weak coal market, this limited partnership has been posting record results. Production increases have been able to offset weak coal prices and allowed Alliance to gain market share. This year should see another record and more quarterly dividend increases.
With a yield of around 6.3%, this domestically focused coal company is set to pay investors and rebound strongly as natural gas prices make coal more desirable to utilities.
Cheap prices have been a boon to demand for natural gas recently. However, there are long-term trends afoot that should support still higher prices. The biggest factor will be the creation of a notable export market, which doesn't really exist in the United States today. Natural gas being used as a vehicle fuel is another support.
Ultra is a high-risk and direct play on rising prices, while high-yielding Shell shares offer notable exposure backed by a solid and diversified business. Alliance, meanwhile, is a high-yield option that will benefit indirectly for those seeking a contrarian investment.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Alliance Resource Partners, L.P. and Ultra Petroleum. The Motley Fool owns shares of Ultra Petroleum and has the following options: Long Jan 2014 $30 Calls on Ultra Petroleum, Long Jan 2014 $40 Calls on Ultra Petroleum, and Long Jan 2014 $50 Calls on Ultra Petroleum. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!