11/20/2009
By Conley Turner, Research Analyst

Despite attempts to stage a sustained recovery in recent weeks, the price of natural gas is still at multiyear lows.   Whether or not this latest price increase is sustainable in the short term is the subject of debate as the fundamentals surrounding the commodity continue to be very bearish. Nonetheless, looking beyond the current factors, a case can be made for natural gas being an attractive investment option over the long haul. 

Natural gas currently accounts for approximately a quarter of the total amount of energy used in the United States.  At present, there is an abundance of the commodity being held in storage.   Techniques and technologies have evolved in recent years rendering its production very efficient. This is evidenced by the fact that though net rig count in North America has been significantly reduced due to the economic downturn, production figures for natural gas have still increased dramatically versus prior year levels. 

Previously uneconomical wells and geographically challenging areas are now accessible due to the advances in drilling technology.  Furthermore, the number of locations available for exploration has increased substantially. One such area is Barnett Shale in Texas, which is arguably the largest natural gas field in the US with an estimated 30 trillion cubic feet of commodity available. These factors combined with all the imports of gas from other countries serves to explain why inventory levels continue to build while demand remains tepid.

Of gas consumed in the U.S, approximately 22% of the total is used in the production of electricity. Coal on the other hand accounts for approximately half of the amount of the electricity generated.   This is meaningful as natural gas has a smaller carbon footprint than either oil or coal. As such, it will likely be the fuel source of choice should the US Congress pass legislation to limit green house gas emissions in the fight against climate change.

Power plants that use gas to generate electricity do so more efficiently than coal and it is less expensive to transport gas than it is to move coal. The passage of so called green legislation would likely spur demand for natural gas by industry and lead to an increase in the number of power plants using it as the primary source of fuel.  The switch from coal to natural gas is already occurring among many utility companies and progressing steadily. According to the U.S. Department of Energy, a projected 13% increase in demand for natural gas will occur by the year 2030.  However, this figure will undoubtedly be revised upward should laws be enacted to limit emissions. 

Another factor that may favorably impact natural gas prices is the current weakness in the U.S. dollar.  Despite the recent price volatility, the greenback is in a secular decline versus a basket of other international currencies.  A weaker dollar makes for more favorable pricing of products that are denominated in dollars to those paying in stronger  currencies. As such, it follows that there is the possibility of increasing international demand for gas as a result of the weakening greenback and this can act as an offset to the impact of the high inventory levels.

Given this backdrop, the view of building positions in those companies that produce natural gas as opposed to oil as the primary source of fuel should be considered.  Due to lower energy costs, these companies may actually be able to see margins expand as well as overall profitability.  It stands to reason then that with all the pessimism surrounding natural gas, this may be the best time to make a calculated bet that could pay off in the long run.  At this point, the exchange traded fund (UNG) is one of the most efficient ways to for investors to gain exposure to natural gas prices.

Conley Turner
Wall Street Strategies