Natural Gas: A Look at the Contrarian View

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

With plentiful supplies and high production driving natural gas prices to their lowest levels in a decade, interest in its potential — and how it might be played on Wall Street — is strong and growing stronger. Accordingly, there’s been an increasing level of chatter about the likely future role of natural gas in a wide range of applications that touch a number of high-profile industries 

I believe there are definite long-term opportunities here, and a number of short-term possibilities as well. I’ve posted several positive articles on the topic in recent weeks, including one on energy companies shifting toward its use in oil and gas operations, one on its rapid adoption by some transportation industry stalwarts, and one on Caterpillar’s (NYSE: CAT) emergence as a leader in product development.

The top dogs

Companies that will benefit the most from what is obviously a trend include Royal Dutch Shell (NYSE: RDS-A), which produced more natural gas than oil last year for the first time in the company’s history; Westport Innovations (NASDAQ: WPRT), widely considered the most advanced gas-injection engine designer in the field and a partner with many of the other top players; Clean Energy Fuels (NASDAQ: CLNE), already the transportation industry’s largest provider of natural gas and currently in the process of building a “natural gas highway” across North America; PACCAR (NASDAQ: PCAR), which holds the lead in the natural gas heavy-duty truck market with 40% share and six new models being introduced in 2013; and CAT, which is developing off-highway mining trucks, giant haul trucks, railroad locomotive engines, oil rigs, power-generation equipment, marine engines and other gas-powered products.

But not everyone thinks the movement from petroleum to natural gas will take place quickly — or whether a transformation as big as the one envisioned by some proponents will really ever happen at all. “It’s hysteria,” said the spokesman for a petroleum advocacy group.

With that in mind, let’s take a look at the key arguments these skeptics raise.

Four contrarian points

The upfront cost of the new technology is high. Most estimate that heavy-duty trucks powered by Liquefied Natural Gas, or LNG, cost $80,000 more than diesel trucks. Even at today’s natural gas prices, that could mean a 4-year payback — in an industry that prefers payback in 12 to 18 months. Gas engines for oil rigs run about 50% higher those powered by diesel, and conversions can run nearly $1 million per rig. These economics also raise eyebrows.

Natural gas prices are not likely to remain as low as they are now. Many suspect the current 30%-40% cost advantage of natural gas over diesel — its prime advantage — may only be temporary. Declines in availability or increases in production costs (see the next point) could dramatically shrink that spread. Some also believe that a boom in demand will actually cause prices to rise as companies in the loop find ways to boost their profits.

Production methods are controversial, and it’s difficult to transport the product to many of its best potential end users. To a lot of people outside the industry, fracking has become a dirty word. As a result, substantial state and federal restrictions that could impede natural gas production are distinct possibilities. But even after it is produced, there is no infrastructure at present that can be employed to easily transport the gas to the oil fields and filling stations where it would be used.

There is a lot of interest, but few are placing orders so far. “Everybody wants to talk about it but not many are actually buying,” said an executive with a Class 8 truck maker with numerous LNG vehicles now in his line. Rigs running on natural gas in the North American oil patch are likewise getting a lot of press, even if only a couple dozen are actually using it today. Caterpillar has a big slate of gas-powered products in development but most won’t be available for as much as five years.

The bottom line

These arguments may all be valid to some degree, but I continue to feel there is a big future ahead for natural gas and the companies that figure out how to sell its benefits to their customers. The domestic industry is off and running. International reserves are abundant and a number of key countries like China have thrown government support behind it. Shell projects global demand for LNG will double to 400 million tons by 2020, while Compressed Natural Gas or CNG is growing in popularity among major operators of smaller vehicles like Federal ExpressUnited Parcel Service and Waste Management.

As for the specific contrarian points noted above, the upfront costs do not seem a game breaker and fears of massive price hikes and serious production restrictions — while worthy of consideration — are for now just speculative. Additionally, the leading companies mentioned above are among those actively addressing the other issues. Clean Energy Fuels, for example, is working on production and supply by expanding its current 70 LNG fueling stations in 33 states to 150 and buying two LNG plants to process the fuel so it can be delivered to these stations. Westport Innovations has partnered with a number of major players like General Electric and Cummins to develop improved LNG engine technology. PACCAR's well-regarded and popular Kenworth and Peterbilt lines will be featuring more and more LNG trucks going forward. CAT is developing a larger selection of these products than anyone else, most of them variations on top-selling petroleum-driven products already in their vast lineup. And Shell is not only producing more gas than ever, it is also working hard to promote the fuel and the shift among its peers, suppliers and customers.

We all know that any new technological shift takes time, and the natural gas industry is certainly one that could experience its share of fits and starts along the way. But from this spot, the potential still looks very positive.

Fool blogger Howard Rothman does not own shares in any of the companies mentioned in this entry. The Motley Fool recommends Clean Energy Fuels, Paccar, and Westport Innovations. The Motley Fool owns shares of Clean Energy Fuels, Paccar, and Westport Innovations. 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!

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