Natural Gas: the Fossil Fuel of the Near-Future

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

There is no way that natural gas can remain as cheap as it is in the United States without demand eventually catching up. Natural gas is not a cheap inferior fuel; in fact, it is a fantastic fuel that is cleaner than the swill we use now. Obviously, it is not a solution to the energy crisis that will eventually arrive if we rely on extracted fossil fuels, but it is a good stopgap. This stopgap has the benefit of moving the US's energy supply domestically.

On the supply-side there are still depressed prices, and the economic woes of the last half decade have meant that demand has not caught up. There is no rapid adoption of natural gas, but it is progressing. Even in a great economy a transition would take a long time.

I like focusing on cars for natural gas because I think that will be one of the most important sources of future demand. I expect automotive margins to be larger than industrial margins, even if industrial demand accounts for more absolute volume. When I am talking about demand I do not just mean natural gas, but all the things requires to make use of it. Storage, engines, and distribution equipment are needed in addition to the gas itself.

I have written about natural gas before, and I still really like Linn Energy (NASDAQ: LINE) and its non-partnership vehicle Linn Co (NASDAQ: LNCO). Linn Co was incorporated to simplify taxes, which get tricky with partnerships, but simpler taxes does not mean favorable tax treatment. Linn is a natural gas producer that does not engage in exploration, but purchases fields from other companies and hedges the price of natural gas. This sometimes reduces profits, but ensures that declines in prices do not affect the company's profitability.

Linn admirably demonstrated the pitfalls of poor hedging decisions, wiping out 93% of its operating revenue. I extend my thanks to the company for really driving home the lesson about hedging; it was worth every penny. Flippancy aside, Linn was too expensive before, but it is not anymore. The reaction to the bad news is overblown. I always love it when the market overreacts. Linn has still been acquiring more properties, and a bitter lesson will not go ignored. The acquisitions are particularly important, because they are not saddled with the burden of old contracts.

I really do think that in the very long-term Linn will be a fantastic investment, but you need to be patient with the bumps. Just see the recent pummeling as an opportunity to get in far cheaper. I liked Linn in a previous article, and buying then would have been a bad call. I was hesitant about its price, but for a buy and hold style investment you sometimes must swallow the bitter pill. The big picture has not changed for me. I just hope that the company does not to go through any more painfully illustrative lessons.

I also considered big automotive applications last time, such as engines. This time I want to look at smaller components, because more potential can be unlocked. Fuel Systems Solutions (NASDAQ: FSYS) is a small company with a market cap of $252 million, which is far smaller than Westport. The recent earnings highlighted something paradoxical. The long-suffering European markets are actually looking strong, while Asia is the weaker market. Asia is weaker in that it presented as flat last quarter instead of posting growth. Considering the macroeconomic environment, that seems odd, but upon closer inspection it is good news. If savings can be gained from switching to natural gas, Europe will be interested, because it is hurting so bad.

On the North American front, Fuel Systems mentioned increasing orders from General Motors (NYSE: GM) as it rolls out bi-fuel pick-up trucks that can use natural gas. Fuel Systems is also working with Ford. However, management mentioned a bit of a slowdown in the US citing timing issues. Many companies complain that US companies are pushing orders into the next year. Those companies seem to be waiting from a supernatural sign that things have suddenly improved before they release parts of the massive cash piles. Overall, the company seems poised for growth as natural gas becomes more prominent. It is a smaller company so it should be invested in like a growth story with solid potential. However, do not let it occupy a place in your portfolio akin to a blue chip.

It is a good idea to keep an eye out on the success of these new GM vehicles, because they present an important step to transitioning over to natural gas from oil. It might not happen for all vehicles but there is a big push to transform workhorse vehicles into natural gas vehicles. These include buses, trucks, pickups, civic vehicles, and even taxis. Some of those plans are only in discussion, but some are being enacted. If GM is on the forefront of this new technology, it should do well.

I think Fuel Systems warrants more attention, but there is far more research to do. However, it is a smaller company in an emerging industry. To me that seems like a lot of potential, but I would want to look back through the years and see how the company has moved forward before I decide if I really like it. Linn is better now than it was before, because I think the decline was a bit overdone. Acquisitions mean new opportunities, and there is a chance that Linn can wipe the stains of the past. GM is extremely popular, but seems to be doing its best to innovate. I would look at it more when I consider automotive companies, but I think natural gas pick-ups is a good idea. I look forward to seeing how those sell.

TheArchivist has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend General Motors Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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