A strategy--and three stocks--for making money from the global boom in natural gas

06/22/2012 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

How do you make money out of the current U.S. and global natural gas boom?

It’s harder than it looks since the explosion in U.S. natural gas production—a 21.6% increase from 2002 to 2011—has helped crush natural gas prices in the United States. Natural gas futures in New York closed on June 20 at $2.52 per million BTUs. That’s down from the $10.36 price of natural gas in June 2008. With the breakeven cost of producing natural gas in the United States somewhere between $4 and $8 per million BTUs, you can see how this might not be the most profitable time to be a natural gas producer. Shares of Chesapeake Energy (CHK), for example, were down 31% for the 12 months that ended on June 20, 2012.

But I think three recent news items give investors the skeleton of a strategy for profiting from what is a global boom in natural gas. I’ll finish by putting some flesh on that skeleton with three stock picks in the sector.

Here’s the first news story: On June 18 ExxonMobil (XOM) announced that it was shutting down its efforts to find natural gas in Poland’s shale formations.

This isn’t the first bad news that natural gas exploration companies have received in Poland recently. On early estimates Poland looked like it might provide a replay of the natural gas shale story in the United States—the U.S. Energy Information Administration had estimated that Poland might have 5.3 trillion cubic meters of natural gas locked up in its shale geology. That would have given the country the largest gas reserves in Europe. But more recent estimates by geologists working for the Polish government trimmed those estimates to 350 billion to 770 billion cubic meters. That’s still a lot of natural gas for a country that currently imports two-thirds of its 14 billion cubic meters of annual consumption.

But the ExxonMobil pullout was actually more puzzling than just simply more bad news. The company had drilled just two test wells before deciding to pull up stakes.

The suspicion among other exploration companies in Poland is that ExxonMobil’s decision had less to do with two dry wells in Poland than it does with ExxonMobil’s deal last week to develop shale oil reserves in Siberia with Russia’s Rosneft.

My conclusion: I think ExxonMobil bailed on Poland for two reasons. First, time. The length of time that would be needed to develop natural gas volumes in Poland is just too long, especially if you include the need to build infrastructure. The Polish government projects that the country could see it’s first commercial gas production in 2014-2015 at a very modest 0.5 billion to 1 billion cubic meters. And that only gets the gas out of the ground. Then there’s the time and expense of developing the infrastructure to get the gas to Polish consumers and potentially to consumers outside of Poland. The more time, the more risk, since, although no one is sure how long it will be before large volumes of cheap liquefied natural gas will be available to Poland, the plans now on the books point to 2015 to 2018 with 2018 being more likely, in my opinion. Second, natural gas economics continue to decay. ExxonMobil’s preference for investing in Russia oil shale against Polish gas shale makes perfect sense if you consider that no one is quite certain where the bottom might be for natural gas prices—and for how long the current premium price for gas delivered in Europe or Asia might last.

Here’s the second news story: And it fits right in with where I’ve left Poland and ExxonMobil. The U.S. Department of Energy estimates that production of natural gas liquids hit an all-time high in March and is now 50% above 2009 production. That has driven the price of some natural gas liquids down by 60% in the last year. Ethane, for example, now sells for just 8 cents a pound, and some market analysts think that producers could wind up giving ethane away for free later this summer. Which is really bad news for, especially, U.S. natural gas producers since they’ve been counting on sales of liquids such as ethane, propane, and butane that can be stripped out of the natural gas stream to make up for plunging prices of natural gas itself. This has the effect of cutting cash flow at natural gas producers and that’s not good news for natural gas exploration and production. It adds just another layer of uncertainty for natural gas producers.

My conclusion: With the economics of natural gas under pressure from this new direction, it’s no wonder if a producer such as ExxonMobil might decide to go with oil over natural gas. In addition this new wrinkle undercuts the premium that investors have been willing to pay for the shares of natural gas producers with big positions in liquid-rich geologies in the United States. (In other words, this isn’t good news for companies such as Pioneer Natural Resources (PXD) or Concho Resources (CXO). Or for oil services companies with exposure to U.S. exploration and development such as Halliburton (HAL) and to a lesser extent Schlumberger (SLB). It is good news for chemical companies, such as Dow Chemical (DOW), DuPont (DD), and Lyondell Basel Industries (LYB) that use natural gas liquids such as ethane and butane for feedstock.)

Here’s the third news story: Norwegian oil and gas producer Statoil (STO) has signed an agreement with Malaysia’s state-owned energy company Petronas to deliver liquefied natural gas to a terminal in Malacca. Malaysia’s first liquefied natural gas terminal is set to open this summer with the first Statoil delivery due in August. (Statoil also opened its first liquefied natural gas trading station in Singapore on June 1.) Malaysia has traditionally been a major exporter of natural gas to Japan, South Korea, and Taiwan, but with domestic demand rising and supplies failing to keep pace, the country sees itself becoming a long-term importer.

My conclusion: While natural gas prices may have collapsed in the United States, they’ve soared in Asia. High levels of demand from Japan, where the country is using natural gas power plants to make up from the shutdown of nuclear plants after the Fukushima disaster, and increased demand for electricity across developing Asia, have driven spot prices for liquefied natural gas to $18 per million BTUs. (Demand climbed 12% in Japan, 31% in China, and 39% in India in 2011.) The current spot price is a 35% increase in the past year and a huge premium to the $2.52 per million BTUs price in the United States. If you can get liquefied natural gas to the markets that want it, a natural gas producer can make a very nice profit. Unfortunately, the first U.S. liquefied natural gas export terminal isn’t scheduled to go into operation until 2015 to 2016.

I’d still like to add the company with the first permit to build that export terminal, Cheniere Energy (LNG), to my portfolio at the right price. I added it to my watch list http://jubakpicks.com/ on May 11 with an $11 buying price in my post http://jubakpicks.com/2012/05/11/buy-on-the-dip-in-this-market-carefully-very-carefully-but-the-bargains-are-out-there/ .

So Cheniere Energy is one of my three stock picks in natural gas for this column (even if not quite yet.)

I’d also recommend Statoil (STO), which is already a member of my Jubak’s Picks portfolio http://jubakpicks.com/ The company has the export infrastructure in place to ship liquefied natural gas—the company’s Snoehvit plant, capable of liquefying 5.8 billion cubic meters a year, is the only LNG production facility in Europe. And recently the company has signed a deal to buy into exploration permits in Australia’s Northern Territories. Australia is on a path to become a major platform for the export of liquefied natural gas to Asia by 2015.

My third pick in natural gas is BG Group (BG.LN in London or BRGYY in New York). The company has equity stakes in liquefied natural gas terminals in Trinidad and Tobago, and Egypt. It is building an export terminal in Queensland Australia with operation scheduled for 2014. It has plans to open a U.S. export plant in Lake Charles with construction to begin in 2014. And it is in site studies for a terminal in Tanzania. Tanzania may be an oil frontier that’s new to you but recent discoveries have almost tripled estimated natural gas reserves to 28.7 trillion cubic feet. The latest discoveries came from BG Group in May and by Statoil on June 14.

And those are my three suggestions on how to profit from the natural gas boom.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of BG Group, Pioneer Natural Resources, Schlumberger, and Statoil as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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