Anyone searching for long-term gains in natural gas has been through an epic journey in the past year or so. From January 2011 to April 2012, natural gas prices fell an astounding 80%, dragging energy stocks down to new multi-year lows and creating big losses for many energy investors. Take a look at its descending trajectory in the chart below:
But even though on the surface this may look like a colossal failure, the reality is that this decrease is actually a reflection of the industry's success. Energy companies were so successful at extracting more gas from the ground that the market simply became oversupplied and prices crashed. It's simple economics. The supply/demand imbalance was exacerbated by an infrastructure that hasn't fully migrated to a widespread natural gas consumption.
But now, after a tough year and a half for natural gas and energy stocks, the tide has begun to shift. After falling to a four-year low below $2 in April, natural gas has quickly rallied back up 25% in the past six months. Take a look at the extended move lower and recent rebound...
Rising prices, or even price stability, will have a positive effect on the energy industry in general. Old natural gas projects will consequently become more profitable, while new projects will have less risk of reporting losses. In the meantime, as more electric utilities convert from coal to natural gas, the manufacturing infrastructure will start to increasingly demand more natural gas.
But the recent jump in natural gas prices is just a shadow of what's about to happen.
Simply put, the United States could soon become the new Saudi Arabia of the world in terms of energy production. In fact, The Associated Press just released a new report predicting the United States could soon pass Saudi Arabia as the world's largest energy producer because of its huge oil and natural gas reserves, and growing production capacities:
The Department of Energy is forecasting that U.S. production of crude and other liquid hydrocarbons, including biofuels, will average 11.4 million barrels per day next year. With Saudi Arabia projected to produce 11.6 million barrels, it's a virtual dead heat between the two countries. Further down the line, Citibank is projecting domestic production levels of 13 million to 15 million barrels by 2020, which would potentially be enough to dethrone Saudi Arabia as the energy king of the world.
If this prediction proves correct, then North American energy stocks will likely be in position for huge gains. There will be many different sectors and trends to profit from, but six stand out as the defining forces of the booming energy industry in the years to come.
|Integrated and majors|
Large diversified energy companies are one of the most conservative ways to invest in energy. Having global businesses and multiple product and service lines, these integrated players such as Exxon Mobil Corp (XOM) and Conoco Phillips (COP) are more diversified and equipped to navigate volatility in one market or region of the world. Integrated energy companies also typically pay a dividend, an extra attraction in a world on rock-bottom interest rates.
|Exploration and production|
These are the companies that own, buy and lease land used to drill and explore fossil-fuel resources like crude oil and natural gas. This is one of the more aggressive methods of investing in energy, because the price of crude and natural gas heavily affects earnings and cash flows of exploration and production companies. This has weighed on industry leaders such as Apache Corp. (APA) and Anadarko Corp. (APC), both down about 25% on the year, for instance. But this volatility also means more upside as exploration and production companies provide solid leverage to rising crude and gas prices.
Service providers specialize in helping exploration and production companies extract crude and natural gas. This includes a wide range of services, but most frequently consists of drilling services. Service providers' revenue is driven by capital spending from exploration and production companies, so the two have a strong correlation with each other. Service providers are more aggressive than integrated energy stocks, but less aggressive than exploration and production.
Selling consumable goods to energy companies extracting millions of barrels of oil and natural gas per year is a good business. The production process to bring crude and natural gas out of the ground is intense and requires a lot of specialty equipment and resources like sand, water, chemicals and other consumable goods. Carbo Ceramics Inc. (CRR) is one of my favorite stocks in this segment. Carbo sells ceramic propant, a key ingredient used in the hydraulic fracturing boom hitting North America. The company's share price is down 41% this year, which has pushed Carbo deep into value territory.
This is a highly insulated industry. It's just not that easy or inexpensive to build an international network of pipelines capable of transporting millions of barrels of crude and natural gas every year. Pipeline companies such as Buckeye Partners LP (BPL) and El Paso Pipeline Partner LP (EPB), which are incorporated as limited partnerships, require them to pay out 90% of their earnings to shareholders. This creates a solid income stream for many investors.
There is a severe shortage of refining capacities in North America, considered to be a "bottle neck" in the production of gasoline and other consumable petroleum products. But regardless, refiners have had a huge year, driven by record crack spreads that made refining a barrel of crude very profitable. This has Western Refining (WNR) up 86% on the year, and industry competitor Valero Energy Corp (VLO) up 42%. Looking forward, capacities remaining tight in the face of growing production should provide long-term pricing power.
Risks to Consider: The regulatory environment will play a critical factor in new drilling permits and total production levels. Although permits are back on the rise in the Gulf of Mexico, access to additional domestic energy resources in Alaska and the East Coast is still in question.
In spite of the recent bounce, natural gas is still trading at historically low levels. Energy stocks look the same, trading near multi-year lows in spite of strong earnings and cash flows. This makes this the perfect time to take a serious look at the group and select your favorite stocks. Everyone is fearful of energy stocks now, so it's time to be greedy and jump in ahead of the crowd.