Investment Insights

Jeff Benjamin

Natural gas glut creating opportunities for savvy investors

Market is betting that depressed prices will fuel major expansion of related industries

Apr 1, 2012 @ 12:01 am

By Jeff Benjamin

The rising price of crude oil makes it easy to overlook the bargain in another energy source: natural gas.

As investment opportunities go, natural gas is ripe for the picking across a host of subsectors and related industries. Companies that convert diesel-based engines into ones fueled by natural gas, those building fueling stations, and natural gas pipeline companies are the best bets.

“The natural gas in-dustry presents so many opportunities right now because we're in a fairly pronounced valley,” said Skip Aylesworth, manager of the $600 million FBR Gas Utility Index Fund (GASFX).

HISTORIC LOWS

Thanks to a combination of factors including new technology and advancements in exploration techniques, natural gas is being produced in such abundance that prices have come down to historic low levels of around $2.50 per million British thermal units.

The recent warmer winter also contributed to the oversupply, but the trend has been unfolding in earnest over the past few years, which can be good news for savvy investors.

The prices of crude oil and natural gas, which historically have moved in tandem, peaked together in late 2008 and then fell in stride until early 2009 when the decoupling began.

Since that point, the price of oil has increased by 167%, while the price of natural gas has fallen by almost 50%.

“We expect the spread between the price of crude oil and the price of natural gas to be sizable for the next three to five years, and I'm going to be playing that spread,” said Ron Muhlenkamp, manager of the $500 million Muhlenkamp Fund (MUHLX).

He believes that oil probably has peaked for now at around $107 a barrel. Looking at supply-and-demand forces, Mr. Muhlenkamp doesn't see a fundamental reason why it should go much higher. At the same time, he doesn't see much up-side in the price of natural gas and expects prices to stay low until there is a major increase in de-mand.

Low natural gas prices will affect some business sectors and companies more than others. While many companies will benefit, those in the gas exploration and production business are going to be the biggest losers as the price of the commodity stays low.

Most E&P companies, such as Chesapeake Energy Corp. (CHK), will try to dampen the effects of slimmer margins by shifting production from natural gas to oil, where the margins are currently fatter.

Still, Chesapeake's stock is flat from the start of the year and was down 14% last year.

Compare that with El Paso Corp. (EP), a pipeline company that benefits from increased production volume. El Paso shares are up 12.6% this year after gaining 93.4% last year.

Another example in the pipeline category is Williams Cos. Inc. (WMB), which is up 15% this year and gained more than 37% last year.

Other companies also have benefited in anticipation that low prices will spur in-frastructure development and greater use of natural-gas-powered vehicles.

Westport Innovations Inc. (WPRT), for example, is a company that converts petroleum-fueled engines to run on natural gas.

Typically, these conversions cost about $50,000, which make the change uneconomical for most users of gasoline- and diesel-fueled engines. But for owners of long-haul trucks, a conversion from diesel to natural gas could pay for itself in as little as one year, according to Mr. Aylesworth.

Westport's stock, which gained 79.5% last year, is already up nearly 40% this year.

Another play on the fallout from the low price of natural gas is Clean Energy Fuels Corp. (CLNE), which also provides natural gas conversions for petroleum-based engines and is involved as well in building out a nationwide network of natural gas fueling stations.

EXPORT-MINDED

Clean Energy's stock, which was down nearly 10% last year, has gained 92% so far this year.

As the natural gas infrastructure build-out continues, analysts predict that it will take years to drain the current glut of the commodity, primarily because it is so difficult to export.

But for those looking to jump on the export play, there are at least two companies positioning themselves to liquefy and ship natural gas to Europe and Asia, where natural gas is between four and six times more expensive than it is here.

Among the leaders in exporting, the market is currently favoring Cheniere Energy Inc. (LNG), which has seen its stock price jump 73% from the start of the year.

Dominion Resources Inc. (D), which is building a facility to liquefy natural gas for export, has seen its stock decline by 4% this year, while it gained 29% last year.

Questions, observations, stock tips? E-mail Jeff Benjamin at jbenjamin@investmentnews.com. For more on investing visit Twitter @Jeff_Benjamin and LinkedIn's InvestmentNews for Advisers group.

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