The Case for Natural Gas

Here are two helpful and diverse charts and some thoughts to begin this week from an investors point of view.

First, if you are looking for deep discount value, take a look at the two-year chart below, compliments of Yahoo! Finance, of the US Natural Gas ETF (NYSE:UNG) and see if you notice what I notice.

click to enlarge

The 200-day moving (the red line) average is slightly below $39 and the ETF shares are selling at just above $18, the lowest price this ETF has ever traded at. Natural gas spot price per unit is trading now around $4.38. This is a 7-year low.

WHAT DOES THE SPOT PRICE MEAN?

The spot price of Natural Gas is the current price at which Natural Gas can be bought or sold. It is the wholesale price that is quoted if you wanted to buy Natural Gas today. The price is quoted per Million BTUs of energy.

The more dramatic chart is this year's spot price of natural gas which has fallen by two-thirds. Last July, the spot price for gas was a shocking $13 and now it is down to just over $4.30

Besides UNG, other ways to play the idea of an impending rally in natural gas would be to buy the largest independent natural gas producer in the United States, Chesapeake Energy (NYSE: CHK). CEO Aubrey McClendon was recently interviewed on CNBC. Due to many factors, including the fact that he had purchased CHK shares on margin, he had the mother of all margin calls when the stock plummeted from $74 a share. We are told he sold $31 million shares at around $18 per share and by the rules he can't buy back until April of this year.

McClendon believes that natural gas will be the "go-to" fuel for the Obama administration in their effort to reduce America's dependence on foreign oil and to reduce carbon emissions during the process of creating power and fueling vehicles.

As of December 31, 2007, CHK had 10.879 trillion cubic feet equivalent of proved reserves; and also owned interests in approximately 38,500 producing oil and natural gas wells.They recently had no trouble raising new money to pay off some expiring credit facilities.

The book value per share of CHK is over $27.35 and its balance sheet shows cash of almost $2 billion. One concern is the high debt ratio (.874) and total debt (most-recent-quarter) of $14.35 billion. Their operating cash flow of $5.85 billion should be more than adequate to service that debt factor. McClendon said that natural gas producers like CHK do "very well during times when prices are this low" and they have hedged the majority of their production at around $7 per MMBTU through most of this year. That's encouraging when natural gas currently is at $4.38 per MMBTU.

If you want a rich dividend and a mix of natural gas and oil production, consider BP (NYSE: BP), the former British Petroleum, which reports earnings on Feb.3rd and also owns a 25% state in CHK. With a 7.7% current dividend yield (at $42.79 a share currently) this is an attractive possibility. Its current P/E ratio is just below 5 and the future P/E is a little over 8.

If you are interested in BP, it would be discreet to wait to see how the earnings report goes and how it impacts the stock. It wouldn't surprise this writer to see the stock price test the 52-week low of $37.57.

Any way you slice this pie, you know it's a resource that the world can't live without. Production of natural gas goes way down when the price is this low and that usually sets the stage for future supply shortages. The weather, natural disasters and geopolitical crises can cause some unexpected spikes too.

All we know for sure is that natural gas is more abundant than oil, burns cleaner than oil, and is more plentiful in the US than oil. Sure, natural gas could fall further, but you and I both know that history has taught us that the upside potential from here trumps whatever remaining downside risk that we may experience.

Few investment themes in this day and age have such compelling fundamentals. And there are few natural resources more essential to the energy, transportation, food production and security needs of the world than natural gas.

Take another look at the one-year chart above and ask yourself, "Is natural gas on sale right now?" When is the best time to begin accumulating a "green", natural resource that has had an unprecedented correction? Don't you wish you had loaded up the truck back in November when gold fell to $700 and silver hit $8?

This looks like an opportuntity that comes along just a few times in an investor's life. It might be considered an ideal "long-term investment" with the potential of a "short-term positive surprise".

Disclosure: long ung, chk

Comments

[auto44:]

M.Fitzsimmons, You are right. no one ever accused congress of being smart or honest for that matter.

Feb 02 10:39 AM

[mc2406:]

RE: The 200 day moving average chart: UNG is still considerably below its 50-day moving average and dropping further, so it would appear to be a little early to think about getting on its bandwagon, especially with demand still being down in the forseeable future.

I agree though that natural gas is the quickest, cheapest way to independence from foreign oil. Its price drop has even put Boone Pickens plan (a good one) on hold.

Feb 02 10:46 AM

[Mmarrkk:]

Fitz: again, spot on!! Stimulus shtimulus. The current pork laden package should be marked "return to sender" and started over again, with a focus to fixing infrastructure (nat gas transport one item in that), fixing the housing market, etc. And by fixing the housing market, that doesn't mean absolving home owners of any any amount of principle. Refinance them at lower rates, give them longer terms, but do not reduce the principle. that is a give away and they shouldn't be allowed to just have their $100,000 mortgage turned in to a $50,000. Just like elections have consequences (barf, I said that!), so do individual actions. You bought a loan for $100,000, now pay it off! Give them 50 years or 4%, but make them pay back every red cent of the principle.

Gadget: you are right; the author made a pretty big error in his statement that BP owns 25% of CHK. Kind of makes you wonder about the rest of the article when such a big mistake is made. Why not add that Exxon owns 50% of GE?? They don't, but why not include it in the list of bad quotes?? Authors should fact check before the publish. Who do they think they are? Writers for CBS or the New York Times??

Feb 02 11:04 AM

[long_on_oil:]

Purchasing BP is a no brainer. Fantastic yield and no cut in dividends for foreseeable future. Plus, BP is major player in solar, wind and hydrogen in addition to natl gas. Dividend in relation to earnings appears to be safe for years to come, but there is no guarantee. It gives major reassurance when management has been dedicated to growing share holder value and protecting the dividend. Looking at the dividend history in yahoo gives one a warm and fuzzy feeling about BP.

Feb 02 11:17 AM

[sparkyboy:]

Some very good arguments both for and against the long camp in the comments section. I went "cautiously" long on the Canadian HNU on Friday and I like the suggestion of BP. However a move through 750 on the S&P 500 and "the falling tide will lower all boats", as the saying goes. So maybe its better to take smaller positions frequently over the next few weeks and months and average your cost. I would expect and hope to do well in a 2-3 year time horizon on NG given production cutbacks of late.

Feb 02 12:21 PM

[econjunkie:]

Nat gas demand in the long-run will increase from new power gen. Currently available renewables can't provide the capacity increases required to meet load. Add to this the fact that heating demand in the Northeast is relatively inelastic. Subtract from this the absolute crushing industrial demand has taken, growing inventories due to the lag in well shut-ins (a lot of these guys are keeping wells flowing gas for cash).

The 200-day MA is incredibly deceiving given that the front-end of said metric takes into account one of the biggest BS run-ups in the history of gas pricing.

Long run gas looks good, but I don't expect $10 prices anytime soon.

Disclosure: long UNG

Feb 02 12:46 PM

[Stone Fox C...:]

The interesting point about supply/demand and the reduced amount of rigs now is that a company like CHK loses 30% of production each year. Supply will drop pretty rapidly with the reduced drilling rigs being used. As mentioned in a previoius comment about SLB, the rapid increase in rigs in the last few years never led to substantial inventory increases. Prices are likely to rise pretty fast again as the supply part of the equation was never solved.

Gould said in a company release. "The age of the production base, accelerating decline rates and the smaller size of recently developed fields will mean that any prolonged reduction in investment will sow the seeds of a strong rebound."

Feb 02 01:08 PM

[sr9web:]

HNU?

Why buy that?


On Feb 01 06:08 PM Nick Waddell wrote:

> Marc,
>
> Great info, thanks. Too bad I bought the Canadian ETF (seekingalpha.com/symbo...)
> in November. It looked cheap at around $6 then. It is struggling
> to hang onto $3 now. Your article got me thinking of averaging down,
> though....

Feb 02 05:34 PM

[Factzplz:]

CHK owns 24,000 sq. miles of land or lease rights. No other company comes close to this much oil/gas land.

CHK has 30,000 sq. miles of 3-D seismic data, which is why when 3 other oil companies failed to find gas in Haynesville, CHK found the largest gas find in the history of the US and 5th largest in the world.

CHK has its own 100,000 sq. ft. compressor building operation.

So, the debt, is not high when you factor in what it owns. CHK on that land has an exstimated 168 trillion cf of gas -- half of the current proved reserves of North America.

CHK is the most undervalued gas company -- bar none. CHK has all this land and 12 tcf of gas + $2 billion of cash, and has a market value of $10 billion. Versus XTO with a $21 billion market cap but has 1/2 the cash at $1 billion, and 11 tcf of gas, but the unproved unreserved gas is not known.

On this alone CHK is 1/4 the value that it should be at.

In time, the value will be realized.

Feb 02 08:53 PM

[auto44:]

Don't forget Sara's pipeline from Alaska if it ever gets built what will that do to the market

Feb 02 09:27 PM

[bcncv:]

I've always been interested in natural gas for the long term. Can't say I've studied it much for the short term. The economics of using it just make too much sense, especially if a tax/cap/whatever is placed on carbon.

I've also wanted to invest in something that will benefit from Russia's continuing reliance on doubling the price of gas to Europe. I was looking at BG Group (BRGYY) or possibly BP. Any thoughts on those two?

Feb 03 12:53 AM

[Domino412:]

I bought UNG at 33, back in early fall, because I was so sure with winter coming on and demand would rise, that it too would rise. I sold it at 29 and glad i did. Its now 19. With winter winding down and industrial demand down, I don't see nat gas breaking 5 bucks any time this year.

Feb 03 11:14 AM

[the_lazy_ob...:]

the downward trend of natural gas prices, like the trend in oil, has more to do with the credit tightening than with fundamental factors within the energy market. if the credit freeze will not thaw, it doesn't matter if actual demand for natural gas picks up (which is more likely to drop) or if obama declares natural gas as the national fuel for environment-loving americans.

Feb 03 11:15 AM

[the_lazy_ob...:]

the downward trend of natural gas prices, like the trend in oil, has more to do with the credit tightening than with fundamental factors within the energy market. if the credit freeze will not thaw, it doesn't matter if actual demand for natural gas picks up (which is more likely to drop) or if obama declares natural gas as the national fuel for environment-loving americans.

Feb 03 11:15 AM

[Jake Berzon:]

I like both CHK and BP at current prices, as well. On the other hand, we are facing the toughest economic crisis in decades and technical bears are leading the way. I will be watching for new trends to start emerging before jumping in.

Feb 03 01:02 PM

[cmdrrgh:]

Here in West Virginia you would never know it was going for $4.60 on the market when were paying $16.50 at our homes, thanks to the West Virginia PUC.

Feb 03 09:42 PM

[PeteK:]

sparkyboy;
Don't forget starting 2011 the Canadian gov will tax the hell out of any dividends. Taxation is what they are famous for.

Feb 05 06:25 AM

[simon shain...:]

The Marcellus Shael in Pennsylvania will change the natural gas industry. I know. I have an oil terminal that has gotten alot of attention from the major NG companies. Also, anyone who can store millions of gallons of water will benefit as billions of gallons are needed to 'frac' the shale.

Feb 11 09:39 AM

[sbenard:]

Natural gas has fallen through the floor over the weekend due to news that new supplies are going to increase 30% over the next two years.

Does anyone know of an ETF registered in the U.S. to short nat gas? If so, could you please PM me with the ticker symbol? Thanks!

Mar 09 01:48 PM

[tunaman4u2:]

Good thing no one got back to sbenard eh? You would have been crushed if you went short nat gas now (March 13th)

Mar 20 04:14 PM