X Marks the Spot in Energy

06/18/2012 11:15 am EST

Focus: STOCKS

Paul Larson

Editor, Morningstar StockInvestor

An oil giant and a nuclear-powered utility aren’t getting the credit they deserve, says Paul Larson, editor of Morningstar StockInvestor.

Natural gas and investors. I’m with Paul Larson right now from Morningstar and Paul, prices are almost at an all-time low right now. What’s your take on that?

Yeah, natural gas prices are very low right now, and we think that the saying that nothing cures low prices like low prices certainly applies to this market today, with the gas prices around not much higher than $2 per 1,000 cubic feet.

That’s a price where the drillers are really having a hard time attaining return on their drilling investment. So we think that on the supply side, supply is not going to grow nearly as fast as it has in recent years.

Meanwhile, on the demand side, we think that demand is going to begin to ramp up, because again, that low price is really incentivizing switching from other fuels to natural gas. You see utilities all over the country closing coal plants and turning to gas-fired power generation, and also we’re starting to see the very beginnings of natural gas being used as a transportation fuel, which could really have a significant effect on the overall demand in this country.

So, when natural gas prices do rebound—which they will at some point, we imagine—what stock might benefit?

Well, beyond the natural gas producers right now, which are quite depressed, one stock that I like that has as we call it at Morningstar, a wide economic moat, is a company called Exelon (EXC). This is a power generator, and they own the largest nuclear power fleet in the country.

They are very sensitive to electricity prices, and the electricity prices are driven by natural gas prices, so electricity prices are quite low right now. But when natural gas prices go up, electricity prices should also go up, and Exelon is going to be in a prime position to benefit from that. While we’re waiting for that to happen, the stock has a yield in excess of 5%, so we get paid a nice price to wait.

As we go from natural gas to the other gas, folks are curious about the gas prices. What do you say?

Well, right now we’re in a seasonally tight period, so gasoline prices are probably not going to drop precipitously from here. You never know. They’re very unpredictable.

But regarding the underlying oil price, we think that oil prices, unlike natural gas prices, are probably about where they should be in terms of the long-term supply and demand balance. Whereas natural gas prices, we see them rebounding significantly. We don’t see oil spiking significantly from here. Although, again, these are commodities that are very hard to predict.

Any stock to watch in that category?

Sure. One stock that we like is Exxon Mobil (XOM). This is another stock that our company that has a wide economic moat in the oil business.

The rule of thumb is that bigger is better in terms of returns on invested capital, and Exxon Mobil is by far the biggest and also by far the most profitable. Meanwhile, it’s trading at a moderate discount to our estimate of its intrinsic value. But for a long-term investor, I think that it’s a great holding.

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