The Obama administration's latest set of climate rules might be bad news for the coal industry, but it looks like another leg up for natural gas, both short-term and longer term.
“For natural gas investors, it looks like the wind will be at your back for a number of years,” said Ken Croft, president of Croft Investment Management. “We've been investing in natural gas for a while, and we think a long-term portfolio should definitely have some natural gas investments.”
The longer-term argument for natural gas is based on a growing domestic supply, increased global demand, new efforts to liquefy and transport the resource, and more favorable political treatment compared to coal.
At about $4.50 per million British thermal units, natural gas prices have come back from the bargain-basement prices of around $3 a few years ago. And the dynamics in play create a range of natural gas investment opportunities.
“I'm pretty bullish on natural gas, and my gut tells me it's probably going to be the best-performing purely industrial commodity out there this year,” said Uri Landesman, president of Platinum Partners.
With a general sense that there is almost an unlimited supply, natural gas is not really a supply story. But, according to Mr. Landesman, it is a demand story.
“Places like India and China are very net short of natural gas supplies,” he said. “As those places become more environmentally conscious, natural gas should benefit at the expense of global coal.”
Even though natural gas is a fossil fuel, it is considered cleaner, and therefore more environmentally-friendly, than coal, which was targeted two weeks ago by new Environmental Protection Agency rules.
President Obama announced on June 2 that the EPA is setting limits on carbon emissions output, aimed at reductions of at least 30% by 2030.
The good news for the coal industry is that the benchmark will be set at 2005 emissions output levels, which were about 12% higher on average than current levels.
“I would call the new EPA rules mixed results for the coal industry, but it looks like another driver to push natural gas forward as a more attractive fuel,” said Stewart Glickman, energy equity analyst at S&P Capital IQ. “On a per-million-btu basis, coal is still king as the cost-basis leader, but as you get more coal plants retired because of this ruling and other regulations, that will change.”
Among the companies moving aggressively into the natural gas space are The Dow Chemical Company (DOW), E.I. du Pont de Nemours and Co. (DD), and Exxon Mobil Corp. (XOM), which purchased leading natural gas producer XTO Energy in 2009.
As Mr. Glickman explained, the current price of natural gas is still not at levels that will encourage drillers and producers to favor it over oil, but the handwriting on the wall is getting clearer.
“If you're a producer, you can either drill for natural gas or crude oil or a mixture and right now you typically generate better margins on the crude oil side,” he said. “The last couple of years, drillers have switched over to liquids production and away from gas production.”
Another force behind more natural gas production and/or potentially higher natural gas prices is the recent severe winter weather, which pushed natural gas storage levels 40% below their five-year average.
“You are already seeing some increased production to replenish the natural gas,” said Rob Haworth, senior investment strategist at U.S. Bank Wealth Management. “It could be a couple of years with higher natural gas prices because of the winter.”
Beyond trading natural gas futures contracts, or concentrating in the purest-play natural gas producers, Mr. Glickman advised allocations to some of the mutual funds and exchange-traded funds that are heavily exposed to the category.
Guggenheim S&P Equal Weight Energy ETF (RYE), Waddell & Reed Energy Fund (WEGYX) and Fidelity Select Natural Gas Portfolio (FSNGX) are all funds that have significant natural gas industry exposure, according to Mr. Glickman.
“If you want to be a natural gas bull, you could point to natural gas inventories that are way below the five- and 10-year averages because of the colder winter,” he said. “At the end of the current injection season it's estimated to be back to long-term average levels. But what if there's a second cold winter in a row?”