It's Time to Buy Natural Gas
Jan 24th 2012 3:01PM
Updated Jan 24th 2012 3:02PM
It seems like everyone's been invited to the party lately except for poor old natural gas. Gold, silver, and copper are just months removed from all-time highs, oil is trading very near $100 per barrel again, and even the food-based commodities like coffee, corn, and wheat have had monstrous runs over the past few years. As for natural gas, it's down more than 50% in the past two years.
What's behind the move? Abnormally warm weather across much of the U.S. this winter has crushed demand for the heating agent and driven prices to decade lows. With prices having fallen almost exponentially lower since 2012 began, I think the following question needs to be posed: "Is it time to buy natural gas?" I think the answer is yes, and I can give you a few reasons why and a few good ways to play the frustrating commodity.
Reasons to buy
First, the ratio between the price of oil and the price of natural gas has never been higher. With oil at $98.39 per barrel and natural gas at $2.33 per million BTU, the gap between the two is now at a staggering 41. Historically, the price ratio has vacillated between five and 15 with a widening gap only seen in recent years. The discovery of vast natural gas reserves in the U.S. has contributed to its price decline, but it in no way makes up for the fact that natural gas is still a finite resource. I don't see this pricing inefficiency lasting.
Second, extremely low natural gas prices aren't conducive to supporting the drilling of new wells. The U.S. government and the natural gas drillers clearly want to see natural gas become a more prevalent source of fuel in our world as it's one of the cleanest forms of energy creation. However, this isn't going to happen if it's increasingly unprofitable for them to be drilling new wells. Once demand returns, the likelihood of a knee-jerk spike in natural gas prices is increased, as is the chance that drilling will return en masse following that spike. Â
The other tricky thing about natural gas pricing is that the weather can change in an instant and often isn't a good indicator for the future pricing of natural gas. A warm winter can easily give way to a cold stretch that can spike natural gas prices.
You have to pay to play
Now let me walk you through a couple of different ways you can play what I anticipate will be a sizable rebound for natural gas prices.
One way to play natural gas without having to choose between specific companies is to place your bet on the United States Natural Gas Fund (NYS: UNG) . This ETF seeks to replicate the daily movements of natural gas based on futures contracts on the NYMEX. Unfortunately, tracking futures contracts isn't a perfect science, so the numbers don't translate perfectly some of the time. That's why I actually prefer the iShares S&P North American Natural Resources (NYS: IGE) . This ETF actually measures the performance of dozens of U.S.-listed natural resource companies in the U.S. and Canada and gives you a much more accurate (and less volatile) way of betting on natural gas (as well as other resources).
The reason for including Exxon is simple: It's a large, low-beta, diversified energy company that's going to pay a decent dividend. Following its acquisition of XTO Energy in 2009 and smaller, privately owned natural gas companies since then, Exxon has increased its stake in the Marcellus shale to more than 700,000 acres. Having produced more than $30 billion in profits last year, Exxon is a name that'll help you sleep better at night.
Much like Exxon, Devon Energy has been playing its own version of monopoly with U.S. shale, collecting as much potential drilling acreage as possible. Devon isn't going to pay you nearly the same dividend yield that Exxon will, but it will give you a little more natural gas exposure. Make no mistake, though, Devon still has ample profits from its oil production to fall back on, so like Exxon, you don't have a lot to worry about at night.
Chesapeake Energy is the wild card of the bunch because it has the most direct exposure to natural gas prices. Understandably, a quick spike higher in natural gas prices could move the stock without having a direct impact on Chesapeake's bottom line, so keep that in mind. But being responsible for 8.3% of all U.S. natural gas production, Chesapeake clearly has a vested interest in natural gas pricing and could show the largest move higher when demand finally rebounds.
I've never been good at reading a crystal ball, but at some point logic needs to take over and investors need to realize that despite the newfound reserves, natural gas is still a highly demanded and finite resource. I'm therefore going on the record and calling a bottom in natural gas prices here.
If you're looking for more ideas, check out The Motley Fool's free report, "The Only Energy Stock You'll Ever Need." In it, Fool analysts detail a company that will benefit from the natural gas boom and pays a dividend. Click here to grab a copy.
At the time this article was published Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He'd like to think he's quite a "gas" at parties. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool owns shares of Devon Energy. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 that isn't full of hot air.
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