Last year the talk was that natural gas was as abundant as water and that prices were going to $1. Some even said lower. Well in the commodity markets, the cure to low prices is low prices. Companies in the natural gas space stopped drilling, tightened their belts, sold assets and cut production. The drilling boom that was seen in places like the Marcellus became semi ghost towns. Utility companies made the switch from coal to cheaper natural gas, and 1 year later, we have natural gas prices back above $4 heading towards $5.
Several big names outside the energy space have been making a contrarian bet on natural gas for the past year. Among those are Jeffrey Gundlach, Howard Marks, Wilbur Ross and recently Jeremy Grantham. Grantham argues that natural gas prices are going to triple over the next few years. He may be right. It will all depend on how many facilities receive approval from the Department of Energy to export natural gas.
The price for natural gas is much higher on a worldwide basis, with prices averaging $12. Companies such as Dow Chemical (NYSE:DOW) use natural gas for power and don't want US natural gas exported. They want it to remain here to power American industry. As a result, there are competing lobbying efforts occurring in Washington. On the one side, manufacturers and consumers are saying exporting natural gas will raise their costs. On the other side, there are natural gas producers saying its vital to their survival and that jobs will be created by drilling for more natural gas. On their side, there are global interests that want to import cheaper US gas.
In the immediate term, the outlook for natural gas prices will depend on the weather. Last year's record natural gas inventories were drawn down by a very hot summer and a cold winter. There was also a lot of coal-to-gas switching by power plants. With prices back above $4, some plants will be going back to cheaper coal, and that will mean less demand for natural gas. Natural gas is a weather-driven commodity, and we need another hot summer and cold winter to really get prices moving higher.
In terms of natural gas supply, total U.S. natural gas storage stood at 1.673 trillion cubic feet as of last week. Stocks were 804 billion cubic feet less than last year at this time, and 66 billion cubic feet below the five-year average of 1.739 trillion cubic feet for this time of year.
Supply has come down as companies stopped drilling for natural gas. The number of rigs drilling for natural gas is near 14 year lows. Companies curbed their drilling as low prices made it uneconomical. Producers switched instead to drilling for oil and liquids that are more profitable. It's important to note that the low rig count is for dry natural gas wells, but at all-time highs for oil. Natural gas is still a byproduct when drilling for oil, so natural gas is still flowing into pipelines at a high rate.
To play rising natural gas prices, there are several ways to invest depending on your strategy and risk level.
Exxon Mobil Corporation (NYSE:XOM)
Dividend Yield: 2.60%
Exxon Mobil is the largest producer of natural gas in the United States. Exxon purchased XTO Energy back in 2009, right before natural gas prices collapsed. In terms of timing, it probably was about as bad as it gets in terms of buying high and selling low. Fortunately for Exxon shareholders, a $41 billion acquisition is just a year's profit for Exxon.
Last year when Chesapeake Energy (NYSE:CHK) and other producers were cutting back production, many thought Exxon would as well. Instead Exxon kept its current production rates. Many thought at the time was that Exxon was looking to squeeze the weaker producers and didn't mind the low prices. Exxon isn't as dependent on the price of natural gas as Chesapeake is. So far, Exxon hasn't announced or made any further major acquisitions in the space, but with the all-clear that the low for natural gas is in, Exxon might just do that now.
United States Natural Gas Fund (NYSEARCA:UNG)
UNG is a pure play on the direction of natural gas prices. UNG for a long time was one of the worst investments that you could possibly make. The natural gas futures market had such a terrible contango. What this means is that current natural gas prices were cheaper than future months. UNG would be forced to sell current natural gas futures before they expired and buy the next month, which was more expensive. There was a large spread in natural gas prices, and holders of UNG got screwed every time. There is still contango in the market, but with supplies tightening, it is not that bad. Last year the spread was at times 10 cents or more between months. UNG hit an all-time low last year of $14.25 and just hit a 52-week high above $23.
Chesapeake Energy Corporation (CHK)
Dividend Yield: 1.80%
Chesapeake Energy is the 2nd largest natural gas producer in the United States. The slump in natural gas prices has been painful for Chesapeake and its shareholders. Chesapeake is a pure-play on natural gas, as the company is highly levered and tied to the price of natural gas. According to former CEO Aubrey McClendon, a 10 cent rise in natural gas prices boosts EBITDA for Chesapeake by $100 million.
Former CEO Aubrey McClendon was a permabull on natural gas prices. That hurt the company in more ways than one. For one, he never really diversified the company away from natural gas into higher value oil and liquids. When he started to, it was too late, as the company's balance sheet was too leveraged..
Second, he never properly hedged natural gas prices. He never locked in higher prices for his production. At $5 to $6, he thought that was the bottom. He didn't foresee the drop to under $2. That drop hurt the company dearly, and Chesapeake was forced to unload assets to stay afloat.
All 3 stocks are plays on natural gas. How you invest depends on your risk tolerance. Exxon Mobil is about as safe an energy play as it gets. UNG and Chesapeake will move with the price of natural gas. Exxon Mobil won't. For investors that like the space overall, there's also Range Resources Corporation (NYSE:RRC), Devon Energy Corporation (NYSE:DVN), and Southwestern Energy Company (NYSE:SWN).
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.