Many oil and gas investors are familiar with the name Colonel Drake and his famous Titusville well, and may even be familiar with “the father of natural gas,” William Hart and his Fredonia Gas Light Company. Less well known is our country’s first petroleum engineer, Preston Barmore, who first fractured a well to increase the flow of gas using gun powder in 1858!
You can probably imagine how much the technology has improved in the past 150 years.
Though many Americans are noticing the sub-$3.00 gasoline prices, the American energy renaissance has happened largely off the radar of most Americans, Relatively new technologies, such as micro-seismic imaging, horizontal drilling, hydraulic fracturing and multi-well pad drilling, have enabled oil and gas companies to tap the reserves of previously impenetrable shale rock formations and restore production in formerly “empty” fields.
Horizontal drilling allows drillers to bend a wellbore 90 degrees under the ground and go up to a mile sideways to reach reserves which were previously thought to be impossible to access.
The process of fracking — injecting fluid into a wellbore under high pressure to expand small fractures in stone — has become a real game changer, or in B-school speak, a “disruptive technology.”
The fracking fluid used is 98% water and sand. The water pushes the sand into the cracks of shale formations to fracture the cracks so the oil and gas trapped in the shale can flow out. Yes, there are environmental issues associated with fracking, though most of the issues are due to ignorance; fracking for natural gas is much safer, and better for the environment, than transporting oil.
And yet now it is supposed to be a big problem? Doubtful. Even if environmentalists cause some problems in the short term, there is too much at stake to not proceed with fracking.
Multi-well pad drilling has provided tremendous efficiencies in drilling. Encana (ECA) recently completed 52 wells from one well pad site to drill an entire canyon in Parachute, CO. The pad site on the ground is 4.6 acres, however, using its multi-well pad drilling technology; it was able to access 640 acres of underground shale.
The Wall Street Journal reports new wells are pumping out five times more oil and gas than the largest wells were a decade ago.
It is still early days with these technologies and other advances are being made quickly. When shale drilling first began the proper spacing between wells was estimated at what is proving to be too large of an area per well. “Downspacing” is now allowing two to four times as many wells on the same parcel of land.
Since many shale companies have large acreage parcels already secured and test wells drilled, infill drilling is where the next wave of production increases will likely occur.
Additionally, many of shale plays in the U.S. have multiple pay zones. Instead of hitting just one pay zone beneath the earth, some knowledgeable drillers are able to hit zone upon zone of profitable production. While multiple pay zones have been around for decades, and drilled one at a time, drillers are now capable of drawing from all zones simultaneously.
So, what’s the big deal about some advances in drilling technologies? Just a few years ago, there were over 30 books published with the theme of Peak Oil predicting that the world was going to run out of oil.
And then, as if on cue, the free market once again reigned supreme with U.S. oil production rising by 2.5 million barrels per day from 2008 to 2013. This is the biggest five-year increase in oil production in the history of the United States. In 2013, the U.S. produced more oil than it imported for the first time since 1995. The United States and Canada are producing more oil and natural gas than they have since Texas crude production peaked in the 1970s.
If you have heard anything about the recent events in the American oil and gas industry (other than possibly the Keystone XL Pipeline), it has probably been the near universal chorus of singing the praises of cheap natural gas just waiting to be exploited. Something is definitely going on.
Over the past decade, there has been a colossal shift in the US energy industry. Followers of Hubbert’s Peak (“Peak Oil”) believed oil and natural gas production in the U.S. was on a permanent downslope and the facts supported the theory as oil and gas production had been declining for decades.
And now…. since July, the U.S. is now the world’s largest energy producer… and it could become even bigger. We’re now producing more petroleum than Saudi Arabia. The U.S. has also started exporting oil (technically, barely refined condensate) for the first time in 40 years.
These new technologies have created tremendous surges in production. Each new Permian Basin well is now yielding 65% more oil than it was just three years ago. The Marcellus Shale, the biggest natural gas shale play in the world, has seen production increase from two billion cubic feet per year in 2010 to now more than 15 billion cubic feet, an increase of 650% in just four years, despite the number of drilling rigs declining.
There are some industry experts who estimate the amount of oil and gas in the U.S. to be double the reserves of the entire Middle East, which includes so much natural gas the supply estimates vary from a 100 to 200 year supply. Lord Browne, the ex-CEO of BP, stated America’s shale gas reserves are so huge, our supply is “effectively infinite “and the U.S. will become “completely independent of imported oil, probably by 2030”.
The International Energy Agency says the US will cut its oil imports in half and that it will become a net exporter of natural gas by 2020. Even OPEC is noticing, stating the United States oil production has reached a level “not observed in more than three decades.”
It should be clear the quantity of oil and gas production in the U.S. has increased dramatically and people in the industry believe it will likely continue to increase. Those “in the know” believe the energy boom in the U.S. is likely to be even bigger than currently envisioned and that it has barely begun.
The impact on the U.S. is considerable. Jobs are being created – a new Wal-Mart in North Dakota has starting salaries of $17/hour, pizza delivery guys are making over $50,000/year and truck drivers can easily earn six figures a year. The Texas Oil & Gas Association states the industry now employs over 400,000 people in Texas making an average salary of $120,000 per year. Nationwide, the number of jobs in the oil and gas sector has doubled in the last 10 years, creating 600,000 new jobs between 2009 and 2011. These oil and natural gas workers now account for 8% of the U.S. workforce.
Coal powered electricity plants are being shuttered, helped along by the EPA’s war on coal, and being replaced by natural gas powered plants. In 2013, power generation capacity additions from gas-fired plants were almost seven megawatts greater than the collective capacity from all other power sources combined!
What are the alternatives? “Dirty” coal? Nuclear? Oil? Alternative energy? (not yet) The first three are not likely to have a resurgence in the U.S. and alternative energy is simply too early in its development to make a meaningful impact.
Truck fleets, such as UPS and AT&T, are being converted to Compressed Natural Gas (CNG) from diesel (saving nearly two dollars per gallon equivalent) as the U.S. needs a mobile fuel. Until battery limitations are overcome, electric vehicles will not be answer. Drillers are using natural gas to fuel their drilling rigs and natural gas use is spreading to trains, planes and automobiles. Natural gas is the clear choice for the fuel of the future.
Manufacturing plants which rely on cheap natural gas are being built — chemical, fertilizer and steel making. Conventional wisdom, for those studying the natural gas industry, has North America entering a new era of energy abundance and a manufacturing boom thanks to the “shale gale.”
So, what’s the downside? Is the “shale gale” for real or is it another bubble (in a series of bubbles from Internet stocks, real estate, commodities, and now to the stock market) waiting to burst?
There is no doubt shale gas production over the past decade plus has been phenomenal. Shale gas has gone from zero percent to 50% of U.S. natural gas production, but it could be argued the majority of America’s shale gas basins are already exhibiting declining production.
It is tough to find contrarian opinions, but let’s look at some facts. In 2011, the U.S. Energy Information Administration (EIA) estimated the U.S. had 750 trillion cubic feet (tcf) of underdeveloped technically recoverable shale gas. In 2012, the estimate was reduced to 481 tcf, or less than a 19 year supply at of natural gas based on 2013 rates of production.
Production from shale wells typically falls 60-70% in the first year compared to 50-55% in the first two years in conventional wells.
Bill Powers, in his book Cold, Hungry and in the Dark, argues that declining productivity has already begun. Based on data from the Texas Railroad Commission, the regulator of the oil and gas industry in Texas, natural gas production from all shale fields in Texas is no longer growing. Barnett peaked in 2012, Haynesville is in a steep decline, primarily due to a high decline in production rate from its wells, and Eagle Ford natural gas production has plateaued even though oil production is still rising.
Oil production from the Barnett Shale has fallen from an average of 20,000 barrels of oil per day in 2011 to less than 5000 in the first quarter of 2014, a decline of 75% in only a couple of years.
According to the Michigan Public Service Commission, the Antrim shale, with more than 10,000 wells has produced approximately three tcf of natural gas since the 1980’s. Production peaked in 1998 at roughly ½ billion cubic feet (bcf) per day and has dropped every single year since, going down to 100 million cubic feet (mcf) per day in 2013. And yet, the EIA estimates there are 20 tcf of resources left to recover, nearly seven times more gas than it has already produced in the past three decades. If that amount of gas is really there, why are the daily production levels dropping?
Intek, Inc., a consulting firm employed by the EIA, estimated the amount of oil in the Monterrey Shale in a 2011 report published by the EIA at 15 billion barrels of shale oil. David Hughes, Geologist Emeritus at the Geological Survey of Canada published a contradictory report in 2013 title Drilling California: A Reality Check on the Monterrey Shale which concluded the reserves were far smaller. Other researchers agreed and the EIA has since reduced its estimate to only 600 million barrels, or a reduction of 96 percent!
Aubrey McClendon, the former CEO of Chesapeake Energy predicted in 2009 the Haynesville Shale in Louisiana would “become the largest gas field in the world at 1.5 quadrillion cubic feet.” According to data from the Louisiana Department of Natural Resources, Haynesville peaked in 2012 and production is now down over 50%.
There are only three significant shale plays which are currently growing production: the Bakken (primarily an oil play); the Utica, which is in the early stages, and the Marcellus, undoubtedly one of the largest natural gas fields in the world. Without the huge growth in the Marcellus in the past two years, overall U.S. production would have peaked in 2012.
Despite all this new natural gas, the U.S. is still not producing enough to satisfy its own needs. The deficit is being primarily met by imports from Canada.
Even if production continues to increase, there is the deliverability issue. Much of this new production is taking place in parts of the country which are not traditional producers of oil and gas. This is creating strong demand for midstream providers to build the gathering systems, pipelines and storage tanks required to move the oil and gas from the fields to refiners or customers.
Let’s take this opportunity to knock stupid government regulation – the Merchant Marine Act of 1920, also known as Jones Act. This law requires that all goods transported by water between U.S. ports be carried on U.S.-flag ships, constructed in the United States, owned by U.S. citizens, and crewed by U.S. citizens and U.S. permanent residents.
Due to several pipeline bottlenecks, much of this new oil and gas production is being shipped by tank barges (or railroad cars which cost roughly three times as much to ship compared to a pipeline) regulated by the Jones Act. Using a Jones Act approved vessel to transport crude oil from Texas to the Northeast costs about $7/barrel, or about three times the price of a comparable foreign-flag ship. This could be a real problem for those wanting to export crude since it has to get to the East Coast to export to Europe and there really isn’t any pipeline infrastructure heading in that direction.
To avoid the extra shipping costs of a Jones Act vessel, some refiners, such as Marathon (NYSE: MRO)and Valero (NYSE: VLO), have actually started sending crude to Canada on a foreign-flagged vessel to be processed and then exported back to the U.S. – U.S. maritime industry wins, Canadian refiners win, but U.S. refiners, consumers and common sense lose.
Trinity Industries (NYSE: TRN), which builds the barges (and crude-by-rail shipping containers) and Kirby Corp. (NYSE: KEX), which buys the barges as the largest domestic tank barge operator, are also both big winners, though both appear more than fully valued and ripe for good sized pullback in their stock prices, and are not recommended as investments at this time.
What has happened to natural gas prices?
In 2005, natural gas peaked above $15 per mcf and then the shale gas boom depressed natural gas prices in the U.S as prices fell below $2 by April 2012 at the peak of the shale gale. The demand for gas at such low prices took a little time to normalize as, for example, truck fleets switched from diesel to CNG. The average price for natural gas for all of 2012 was $2.75, the lowest average price in 13 years. Today, the price is around $4, and rising.
So with natural gas (“natty”) prices at or near all-time lows and a lack of access to pipelines and processing plants, drillers simply burned off the gas without consequence, so much that the collective wells in North Dakota could be seen burning gas from outer space. That’s no longer the case.
A new rule set forth by North Dakota’s Industrial Commission requires all oil and gas companies to submit a methane capturing plan with every new drilling permit took effect in North Dakota on June 1st. Drillers will no longer be able to flare gas without incurring a huge financial penalty. The goal is to have the drillers’ capture 85% (and going up to 90%) of the gas they produce by 2016.
The (semi-) free market is already coming up with potential solutions. Devon Energy (NYSE: DVN) is utilizing a new process on its wells known as “green” completions which involves a superior filtration system to capture the natural gas byproducts and feed them into the collection system. This will increase the supply of natural gas even more.
The volatility has been extreme. Last winter, during the polar vortex, spot natural gas prices in the Boston area exceeded $100 per mcf, and averaged $28 for the month of January 2014. A recent Boston Globe article warned of higher electric rates this coming winter due to “a persistent shortage of natural gas generating plants.” New England wholesale electricity costs are nearly double compared to last year, due primarily to pipeline constraints.
Despite the price volatility, this huge new supply of natural gas has created a huge new demand. Known as Say’s Law – aggregate production creates aggregate demand. New fertilizer plants and chemical plants coming on line using large amounts of natural gas will not just shut down due to higher prices as U.S. prices are still significantly lower than most of the rest of the world. Truck, bus, and to some extent, car fleets will not simply disappear due to higher natural gas prices.
There are also supply issues. Last winter’s extremely cold winter, the coldest is thirty years, drew reserves down considerably. The U.S. storage levels are still over 10% less than last year and over 10% less than the five year average.
The Old Farmer’s Almanac is predicting another super-cold winter in the eastern United States with much colder than normal temperatures and above average snowfall hammering the East Coast. Their forecasts are correct about 80% of the time compared to the nightly news forecasts being about 85% correct a week in advance.
El Nino is also something we still have to contend with this winter which means there should be more snow as moisture from the Gulf of Mexico is carried over the U.S.
Regulatory changes are also worth noting, specifically, the lifting of the ban on exporting natural gas and barely refined crude oil.
The natural gas market isn’t a typical global market such as exists for corn, copper or crude oil. Natural gas prices vary widely from country to country since it cannot be as easily shipped as other raw materials. Natural gas shipping requires specialized ships and extremely complex loading and unloading terminals.
In most of Europe the price exceeds $10 (and is highly dependent on Russia for supply), India is $13+, South America $14+, and in Japan, Korea and China the price is over $15 per mcf. This situation will not last, even in a semi-free marketplace.
Applications are being approved on a regular basis now to allow U.S. companies to export Compressed Natural Gas (CNG) or Liquefied Natural Gas (LNG) with the first plant expected to be operational in 2015, with planned exporting capacity already over 35% of the U.S. production. It is difficult to imagine how natural gas prices can stay low in the U.S. with such high prices available around the world. And if the gas boom contrarians are correct, the supply will be much lower than expected, creating even more upside to gas prices.
With all these moving parts, where does one invest? First, let’s differentiate between oil and gas.
With all else being equal, an increase in supply or a decrease in demand will cause prices to decline. Depending on which Middle East countries are at war, the world is essentially in oil equilibrium between supply and demand, with a slight oversupply bias. If oil production continues to increase, without a corresponding demand increase, it will be normal for oil prices to drift lower over time.
Sooner or later – and it may be happening right now – growing domestic supplies of oil will begin to lead oil prices lower. Lower oil prices will reduce drilling, which in turn would reduce the supplies of associated natural gas, and thus higher natural gas prices.
An Eagle Ford or Bakken shale average oil well needs $55-$70 oil to make a profit in order to continue drilling to replace the decline rates of existing shale oil wells. Many other shale oil formations need higher than $70 oil to break even, though some may be as low as $30. The growth of domestic US oil production will become significantly impacted at oil prices below $70. With 15-20% of U.S. natural gas being a byproduct of oil drilling, lower oil prices could decrease the supply of natural gas.
Additionally, much of the world is on the brink of a deflationary depression which will cause oil demand to decrease without a corresponding decrease in supply. There is always the possibility of war breaking out in an oil producing/shipping region which will cause price spikes, but that is speculating, not investing.
Natural gas prices will likely rise significantly. If the bullish production scenario is true, natural gas prices will climb primarily due to higher demand from new users (Say’s Law) and exports of natural gas bringing U.S. prices closer to world prices. Yes, there are shipping costs involved, so the price might not climb all the way to world prices, but the current differential between domestic and international prices is simply too large an opportunity so many companies are looking to find ways to profit from the price gap.
If the bearish production scenario unfolds for the shale gale, prices will be even more likely to rise. I realize this is starting to sound too one-sidedly bullish, but it is difficult for this writer to see how natural gas prices don’t increase significantly, albeit for different reasons.
There are big demand drivers which won’t easily go away; most significantly the EPA’s push to phase out coal fired utility plants (which will likely become natural gas fired plants) and the expected growth in CNG exports. Throw in manufacturers opening new plants or moving back to the U.S. based on the expected low prices and/or high supplies of natural gas and pipeline exports to Mexico and you get increased demand which will be hard to replace.
During the last natural gas crisis in the early-1970’s to mid-1980’s, the U.S. was bailed out by the surge in power produced by coal and nuclear. It is doubtful this will happen again, though an argument could be made for substantial gains in power production from alternative energy sources such as solar, wind or geothermal, especially if more efficient energy storage solutions become available. The long term solution is clearly distributed power systems, but this will take a while to fully develop.
This writer believes natural gas is clearly the better investment compared to oil, and natural gas is likely to rise to at least $10/mcf in the next three years.
An additional central investment theme is there will be a more level natural gas price around the world. Either U.S. natural gas prices increase, natural gas prices in many parts of the world decrease, or some combination of the two (most likely).
Businesses involved in LNG exporting should make a lot of money, at least initially.
The biggest risk in the LNG exporting business (shippers and LNG import/export terminals) is that unless US natural gas production continues growing at a rapid rate, the exporters may run out of natural gas to export.
Please note these two investment themes are non-correlated. If the shale gale bulls are correct, prices of natural gas could stay low and exports would make even more money since the price differential will be larger. If the shale gale bears are correct, the price of natural gas will rise since demand is growing and supply may actually contract, leading to fewer exports.
The simplest way to profit from this expected price rise is to purchase natural gas futures. The February 2018 (and so are February 2019) prices are less than $4.50. For $3000 you can purchase one futures contract which will increase in value at the rate of $10,000 for every one dollar price increase, i.e., if natural gas goes to $9.50 before February 2018, a $5 increase, the profit would be $50,000 per contract.
Most of this article was written a month or two ago, waiting for natural gas prices to decline further to a good entry point. It looks like the bottom is in with an almost $1 price increase over the past couple of weeks. As of today’s close, prices have now retraced an almost exact Fibonacci 61.8% in three waves (meaningful to followers of Elliott Wave Theory) providing an excellent entry point. Prices could decline another 20 cents or so, but with snow now falling, I would rather get in early as this will be a very bullish move.
For record keeping purposes, let’s buy the February 2018 contract at $4.35 or less (less than $4.00, basis December 2014). I highly recommend Interactive Brokers (www.interactivebrokers.com) if you need to open a futures trading account.
Please note, we will want to have plenty of margin to allow the trade to work in our favor so I would suggest having a minimum of $10,000 on deposit for each contract instead of the minimum of $3000. Since each $1.00 increase is worth $10,000 per futures contract, the return will still be substantial. There are also mini futures (symbol QG rather than NG) which are ¼ the size and cost of the regular futures contracts.
Even though the investment theme is bullish on natural gas, it is NOT bullish on the natural gas Electronic Traded Funds (ETF) such as U.S. Natural Gas Fund (NYSE: UNG) as they do not follow natural gas prices very well due to seasonal price swings. Please do not buy and hold UNG – look at a long term chart if you need any further convincing!
A successful investor knows what NOT to invest in as well as knowing what to invest in. Let’s examine some other possible natural gas investment opportunities.
There are many investment advisors who look to derivative investments of an investment theme. For example, if believing the price of gold will go up, one can invest in gold mining stocks; however, this writer believes this is much more difficult as you have to be correct twice.
For example, investing in a frac sand company because you believe natural gas prices going up will spur more drilling. Even if natural gas prices go up, frac sand volume/prices also have to go up. The price of natural gas may go up, but for your frac sand stock to go up, the management has to properly execute. Will there be a miners’ strike which affects the frac sand company? A new mining tax? New competition? The list could go on, but the point is you could be correct in the major theme – natural gas prices rising – and still lose money on your investment due to picking the wrong frac sand stock(s).
Therefore, for our central thesis of an increase in natural gas prices, we want to have as few other events as possible happen to be make money.
Energy companies are commonly divided into three types: upstream, midstream and downstream. They follow the flow of oil and gas from producing wells (upstream) through storage and transportation (midstream) to end-users (downstream). Upstream companies operate at or near the oil and gas wellheads and focus on exploration, drilling and production activities. Midstream companies engage in gathering, processing, compression, transportation and storage activities, moving the product from upstream locations. Downstream companies are involved in refining, marketing and distribution activities.
Additionally, there are the enablers, or the “picks and shovels” companies, such as the facility builders, fracking supplies and contract drillers; and the beneficiaries — manufacturers and electricity producers which use the fuel which might also benefit.
The upstream drillers who find and extract the oil and gas could be good investments, in fact, if you pick the correct companies, it is almost like winning the lottery, however, there is a significant amount of knowledge required to pick the best companies, which ones are in the best shale formations, the best part of the formation, estimating the life of the wells, and knowing the drilling techniques used which would be critical in selecting the best investments.
If you do decide to invest in drillers, spread the money around and diversify between fields, maybe you will get lucky. For Speculators only (not investors), here are three picks which are smaller companies that have recently had their stock prices crushed (down over 50% since June), which have high natural gas production relative to oil and which sport some decent financial metrics.
Approach Resources (NASDAQ: AREX), current price $11.46, engages in the exploration, development, production and acquisition of oil and gas properties. The company focuses on oil and natural gas reserves in oil shale and tight sands located in the Permian Basin in West Texas. It holds interests in the East Texas Basin and the Chama Basin in Northern New Mexico.
It has a Price/Earnings (P/E) ratio of 10 (without extraordinary items), a Price/Book (P/B) of 1 and a Price/Cash Flow (P/CF) of only 6.
Comstock Resources (NYSE: CRK), current price $11.37, oil and natural gas operations are focused in three primary operating areas: the East Texas, North Louisiana, South Texas and West Texas regions. 60% of its production is in natural gas.
P/B is under 1, P/Cash Flow is well under 4 and it pays a dividend of over 4%.
Rex Energy (NASDAQ: REXX), current price $7.29, has properties concentrated in the Appalachian and Illinois regions of the United States. The Illinois Basin focuses on the implementation of enhanced oil recovery on properties as well as conventional oil production. The Appalachian Basin focuses on Marcellus Shale drilling projects.
The valuation metrics aren’t the greatest, but it has 63% of its production in natural gas and operates in the Marcellus Shale which has the greatest upside. It also has the highest growth in sales per share and its stock price has fallen the most.
The midstream pipelines to transport oil and gas (though trains are currently getting lots of extra business transporting oil), and soon ships to transport our natural gas exports could very well be interesting investments, especially for income investors. Pipelines, shippers and storage facilities are like toll roads for energy producers, taking a little piece off all production, regardless of the price of oil and gas. Additionally, in some areas, these companies are effectively monopolies and many pay very nice dividends.
This writer will pass on downstream investments as being correct twice is much more difficult.
The “picks and shovels” plays are also off this writer’s list. It might seem like an easy investment decision to buy providers of the specialized sand used for fracking (“frac sand”), as about 95 billion pounds of it will be used this year and Morgan Stanley is predicting a 96% increase by 2016.
Should you invest in Hi-Crush Partners LP (NYSE: HCLP), one of the fastest growing frac sand suppliers? Or Emerge Energy Partners LP (EMES), which has an even higher quality frac sand and charges a higher price, but also owns a variety of energy transportation and processing services and a rail terminal network?
Or how about U.S. Silica Holdings (NYSE: SLCA) which owns a vast array of sand and aggregate assets used in everything from paint to phone screens, although frac sand is its main product, but with a much lower dividend (and higher dividend growth rate)?
CARBO Ceramics (NYSE: CRR) manufactures ceramic proppant used in place of sand. Due to better uniformity, drillers are supposedly able to increase production compared to sand.
To determine which is the best investment, not only do you need to decide which frac sand company will benefit the most when betting on the “picks and shovels” companies, but you also need to decide if frac sand will continue to be used as the primary fracking aggregate.
Even if you pick correctly as to which company will garner the most sales, there is still market risk. Emerge Energy Services (NYSE: EMES) was down 21.9% for the week ending October 10. EMES is still up nearly 400% since its 2013 IPO, but shed more than 40% in six weeks.
In addition to sand, the fracking process also uses copious amounts of water. Cypress Energy Partners, L.P., (NYSE: CELP), a relatively new company with a large dividend (and stated intention of management to grow the dividend by 10% per year), seems like a good investment. But what if cryogenic fracturing takes off? Liquid nitrogen or carbon dioxide is used, not water. The below freezing liquids should theoretically allow more oil and gas to flow from the shale than water currently does, and should alleviate some environmental concerns.
Another possible company, Chicago Bridge & Iron (NYSE: CBI), which isn’t in Chicago, no longer builds bridges and doesn’t use much iron, is a leading natural gas facilities contactor. Its stock price got whacked recently when Wall Street questioned some of its accounting practices, again, proving the point of having to be correct twice.
This writer believes it is hard enough to be correct once on a major theme, and very difficult to get two dependent calls correct. You can invest in the “picks and shovels,” but this writer believes there are better opportunities available.
There are several keys to successful investing. One of the most important is known as beta, which is the return of that particular market. A stock with a beta of 1.0 will get the market return, though the “market” average is obviously different depending on the market. Some investments will return more than the average and some less, for example, small cap stocks typically have higher betas than large cap stocks, or a leveraged large cap stock will have a higher beta than a non-leveraged large cap stock.
Most investors focus on alpha, an excess, or abnormal, rate of return (risk adjusted) within the group. Beta, being in the right place at the right time, is much more important than attempting to pick the winner in the group. No matter how skilled you are at picking stocks, if the market is crashing, you won’t do too well. The best returns come from being right on beta. The stock picks below are essentially picks on beta.
If you believe in the bullish case for the American energy boom, and expect the volume of oil and gas to increase, regardless of price, the mid-stream pipeline, shippers and storage facilities are a natural investment.
Once the facilities are built, they don’t cost much to maintain, and they can stay in business for decades. The pipeline companies don’t really compete with each other as they typically focus on different geographic regions so overlapping capabilities are rare, making the pipelines a natural monopoly.
Pipelines and storage facilities are just big pieces of metal (and ships aren’t that much more complicated) so there isn’t likely going to be any disruptive technology to displace them and very little money is spent on R&D.
If you believe in inflation (this writer does not), pipelines are a great hedge since many cross state lines and are therefore regulated by the federal government, which typically tie rate increases to the Producer Price Index, which means rates go up with inflation.
Many of these companies are Master Limited Partnerships (MLPs) which combine the tax benefits of limited partnerships with the liquidity of common stock. MLPs are pass through entities which pay zero corporate tax and must pay out 90% of their profits (which is good for income investors). Please note though the distributions are taxed at your ordinary income tax rates, though for many MLPs, much of the distribution is considered a return of capital and not taxed at all. Additionally, special rules may apply for retirement plans.
Storage and pipeline companies:
The U.S. energy boom is one of this decade’s greatest investment themes. (Of course, by the end of this decade, the declines in western stock markets will be remembered as THE investment theme of the decade!) And with more oil and gas, companies that provide the assets needed to store and transport it will continue moving higher in the years to come. Many of these companies operate in more than one segment of the industry, e.g., storage and transportation.
Atlas Pipeline Partners (NYSE: APL), current price $33.00, is a provider of natural gas gathering and processing services in the Anadarko and Permian Basins located in the southwestern and mid-continent regions of the United States; a provider of natural gas gathering services in the Appalachian Basin in the northeastern region of the United States and a provider of natural gas liquid (NGL) transportation services in the southwestern region of the United States. It is currently paying a dividend of over 7.7%.
Energy Transfer Partners (NYSE: ETP), current price $63.63, is one of the biggest transporters of natural gas in the U.S., and is still growing through additional pipelines and acquisitions. A very stable company with a good dividend yield of over 6%. The activities in which it is engaged are all located in the U.S. Its business segments are: intrastate transportation and storage; interstate transportation; midstream, and retail propane, NGL transportation and services segment, and other retail propane related operations.
Niska Gas Storage Partners (NYSE: NKA), current price $4.73,recently announced its second-quarter results, which were very disappointing due to the low natural gas prices, with reported revenue of $15.6 million this past quarter versus last year’s $33.2 million. The company blames the low numbers on a lack of volatility. If this is truly correct, this stock price will certainly rise as volatility is already increasing.
There is a lot to like about this stock at these prices, as the current stock price is well below the $13+ book value per share. It is also the most pure play on natural gas storage which can make lots of money buying at low prices during the summer lull and selling at much higher prices during winter peaks. Please note, if natural gas prices don’t rise quickly and significantly, the stated dividend is likely to be cut, possibly even eliminated for a quarter or two. This could possibly be considered a speculation, but at this price, we will call it an Investment.
Shippers:
Rockefeller made his money in oil primarily through refining and transportation. For our purposes, “refining” natural gas means having a LNG or CNG export terminal. The shippers are in a great “toll road” position since the industry has significant barriers to entry. These ships are expensive, specialized and there aren’t that many of them.
Teekay LNG Partners (NYSE: TGP), current price $38.23, has its entire fleet of vessels under fixed rate contracts which have an average duration of 14 years, though some recent contracts are as long as 45 years. It is an international provider of marine transportation services for LNG, liquefied petroleum gas (LPG) and crude oil. It operates in two segments: liquefied gas segment and conventional tanker segment. The dividend is currently over 7%.
LNG Terminals:
Cheniere Energy Partners (NYSE: CQP) current price $31.56, operates three, 100%-owned, onshore liquefied natural gas, or LNG, receiving terminals along the U.S. Gulf Coast. The Sabine Pass LNG is being transformed into a bi-directional terminal capable of exporting natural gas. It was the first terminal to receive approvals from both the Department of Energy and the Federal Energy Regulatory Commission, and is expected to be the first US terminal exporting natural gas in late 2015 or early 2016.
As the first, CQP should benefit for at least a couple of years of operation with limited operation, and huge profits. The dividend is currently over 5%. This is riskier than the pipelines or shipping companies, and may very well get clobbered in the coming stock market decline, and so is presented here for informational purposes only.
Between the two investment themes – higher natural gas prices and higher natural gas volumes – this writer believes the best bet is on higher natural gas prices. Within the second theme of higher natural gas volumes, APL, ETP and TGP will be recommended for an Income Portfolio, while NKA will go into the Investment Portfolio. These are not equally weighted recommendations – put four times the money on the natural gas futures as you put on each of the individual stocks.
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