Hydraulic fracturing (also known as "fracking") has kept the price of methane (natural gas) and ethane down. This source of natural gas along with gas development overseas promises to provide affordable hydrocarbon gases for years to come.
This has interesting cost-saving ramifications for the steel industry and some chemical companies. Below, I explore firms which could benefit from plentiful methane and ethane that are also trading at attractive prices based on valuation. I will explain why LyondellBasell Industries (NYSE:LYB), Commercial Metals (NYSE:CMC), and United States Steel (NYSE:X) offer investors the best opportunities to gain from plentiful methane and ethane.
Natural Gas Everywhere
Developments in the U.S. shale-gas industry which had revitalized the chemicals industry and boosted domestic energy self-sufficiency aspirations, added another sector to its beneficiaries - the steel industry. Five U.S. steel plants are researching ways to use cheaper gas fuel to purify iron ore in lieu of coal. Austrian steelmaker Voestalpine hinted of constructing a $661 million factory in the U.S., while Nucor (NYSE:NUE) plans to start a $750 million Louisiana project in mid-2013 to benefit from cheap gas. Analysts at Barclays also report a joint venture between Australian steel company Bluescope Steel (OTC:BLSFF) and Cargill, plans to build a (direct-reduced iron) DRI plant in Ohio and India's Essar Global eyes one for Minnesota.
Nucor claims that DRI technology produces iron for the first stage of steelmaking at about $324 a ton, $82 or 20% percent cheaper than conventional blast furnace. Consulting firm Steel Market Intelligence's Managing Partner Michelle Applebaum said, "That technology has been around 30 years, but for 29 years gas prices in the U.S. were so high that the technology was not economical. This is how steel will be built moving forward."
The cheaper alternative may signal a much needed turnaround for the steel industry suffering from overcapacity since 2008. U.S. steelmakers, confronted with low domestic demand, depressed prices and cheap Chinese imports, are struggling to stay profitable.
Gas prices plunged by as much as 50% compared to prices in 2010 due to boost in supplies contributed by hydraulic fracturing of shale rock formations from Texas to West Virginia. Gas futures reached $1.91 per million (British thermal units) BTUs, a decade low, in New York trading last April.
Cheap gas prices reversed the fortunes for U.S. chemical producers like LyondellBasell, which is now planning to build gas-fueled plants worth billions of dollars to tap cheaper fuel. Fertilizer companies including CF Industries Holdings are also planning to construct gas-fueled plants, joining the avalanche of industrial expansion brought by the cheaper fuel. Macquarie Capital steel analyst Aldo Mazzaferro said, "Other companies from around the world that consume gas may be attracted to move their facilities to the U.S. market, which would then provide even more steel consumption and manufacturing capacity. It could result in a re-industrialization of the U.S."
Gas prices may not remain cheap for long. Bloomberg estimated that its average cost would be at $3.70 per million BTUs in 2012 and may go up further if plans to export (liquefied natural gas) LNG by companies like Sempra Energy (NYSE:SRE) and Exxon Mobil (NYSE:XOM) are approved. Domestic capacity to absorb steel production is still low at 74% compared to 91% in 2008 and there are no sure signs that demand will improve.
The World Steel Association estimates that 94% of global iron output is still done through the blast furnace method. Although Nucor will use DRI iron for the final stage of its steelmaking process, the company will still source most of its raw material from scrap steel and recycled steel is susceptible to problems with scrap supply and quality, unlike the DRI iron which doesn't just provide a cost advantage, but also makes smoother, stronger, more ductile and blemish-free steel.
Meanwhile, while U.S. gas supply have been ramped up, Russia's oil and condensate output have risen to a post-Soviet record of 10.38 million average barrels per day last year from 10.27 million barrels per day in 2011, as oil companies took advantage of the increased oil prices. The world's biggest energy producer first achieved 10 million barrels per day out in September 2009 and since then, President Vladimir Putin has set a goal to maintain output at over 10 million barrels per day with plans proposing incentives for offshore and unconventional oil production set to start by the end of the first quarter. Russia's natural-gas production however, slightly decreased by 2.3% to 655 billion cubic meters in 2012.
Chemical Company Winners
Ethane can be used to synthesize ethylene, and ethylene is a fundamental and widely-used chemical feedstock. Thus, more methane and ethane generation leads to cheaper carbon-based chemicals.
LyondellBasell and Westlake Chemical (NYSE:WLK), the largest producers of ethylene in the U.S., have reported highest-ever profits. Dow Chemical (NYSE:DOW) is starting to work with ethane as well in more of its syntheses.
Profit margins are resulting in record increases and are set to go up even further, which ultimately could lead to expanded production capacity, more price competition, and permanently lower carbon-containing chemical feedstocks.
There are a handful of steel companies which trade at attractive valuations:
United States Steel
Commercial metals and United States Steel are trading at compelling multiples. Neither firm has excessive debt. United States Steel trades at the lowest price-to-book multiple and price-to-sales multiple of its peers. Commercial Metal's price-to-sales ratio is almost as cheap and its price-to-earnings ratio is very attractive.
Chemical stocks are valued more richly:
E. I. du Pont de Nemours
Though Mosaic trades at a low price-to-earnings multiple, it would be an unlikely beneficiary of the cheap ethylene story since its phosphate products are not made from ethylene. LyondellBasell, on the other hand, would benefit directly and is one of the cheapest firms based on valuation among its peers and does not have excessive debt financing.
Investors should consider LyondellBasell Industries, Commercial Metals, and United States Steel as ways to play plentiful methane and ethane.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.