Investing in the Pickens Plan, One Year Later

Includes: CHK, ECA, EOG, HMC, KWK
by: EconMatters

This month marks the one-year anniversary of the Pickens Plan. The Plan, which aimed to end America's growing dependence on foreign oil, calls for investing $1 trillion in new wind turbines for power generation in the middle of the country that he said could meet 20% of the nation's electricity needs. While wind is generally regarded as an unreliable source of energy, a key component to the Pickens Plan is the use of natural gas. It proposes moving U.S. heavy trucks toward compressed natural gas (CNG).

Transportation accounts for about 28% of domestic energy consumption. (Fig 1) According to the American Council for an Energy-Efficient Economy (ACEEE), trucks used in freight (medium- to heavy-duty) account for 63% of energy used to transport freight, guzzling 2.4 million barrels of oil a day (MMbd).

According to the U.S. Dept. of Energy (DOE), the United States consumed 20.7 MMbd of petroleum products during 2007 making us the world’s largest petroleum consumer, importing around 60% of it. If these trucks were converted to natural gas engines over the next few years, as proposed by the Pickens Plan, then domestic oil consumption would theoretically fall by about 12% (2.4 MMbd used in freight divided by the 20.7 MMbd consumption).

A recent study done on behalf of the California Energy Commission concludes that CNG vehicles produce up to 29% less greenhouse gas emissions than comparable gasoline vehicles and up to 22% less than comparable diesel vehicles. Therefore, trucks are an important place to look for energy savings in the transportation sector.

Based on a June 2008 study by Navigant Consulting, the U.S. has enough natural gas reserves to last more than 100 years. New drilling technologies such as hydraulic fracturing are unlocking substantial amounts of natural gas from shale rocks. For example, the Haynesville shale play is expected to produce 7 to 8 billion cubic feet of gas a day by 2016. In fact, the amount of natural gas available for production in the U.S. has soared 58% in the past 4 years.

The huge increase in estimated natural gas supplies comes just as concerns about energy security and climate change are prompting the most profound shift in energy policy since the oil shocks of the 1970s. The finding also raises the possibility that natural gas could emerge as a substitute for other fossil fuels to help combat global warming as it burns cleaner than both coal and petroleum.

Natural gas currently accounts for about a quarter of the nation’s total energy use, and 29% of electric power generation (Fig. 1). Coal accounts for about half of the nation’s power generation (Fig. 1), while oil dominates transportation fuels (Fig. 2).

So, it is logical to push some of the coal and petroleum market share towards natural gas, since we have ample domestic supplies.

However, using natural gas in transportation is not without its issues. In its recent Annual Energy Outlook, the Dept. of Energy (DOE) projected a 6% annual growth rate of natural gas used in the transportation sector from 2007 to 2030, the DOE also estimated that transmission of gas to market, compression, and taxes equivalent to those levied on diesel will add at least $7 per million BTUs to the price of gas for trucks and other transport users (Annual Energy Outlook 2009, AEO 2008, Table 13) thereby causing natural gas to lose its price advantage.

There are about 150,000 natural-gas vehicles on U.S. roads today, and 1,500 natural-gas vehicle fueling stations, with only about 750 available for public use. The majority are used by bus and transportation fleet companies like UPS. But according to a UPS case study, CNG technology has a fuel economy penalty of 10%-15% compared with diesel technology.

The UPS study also indicated that CNG trucks require greater use and longer preventive maintenance inspection cycles to contain the otherwise 29% higher maintenance costs in comparison with diesel trucks.

Infrastructure poses another challenge, as the CNG sector has been unable to make any inroads with the consumer market. Until consumers can find natural-gas stations on their way to work, the alternative fuel won't attract commuters. NGVAmerica also says the very limited distribution network for natural gas stations would better serve commercial fleets and long-haul trucks.

For now, Honda (NYSE:HMC) is one of the very few manufactures using CNG technology to target consumers with its Civic GX at 36 mpg highway gasoline gallon equivalent (GGE).

There are also issues that could potentially affect the supply side of the natural gas equation. The sudden increase in supply, combined with a drop in demand amid the recession, has led to a gas glut, pushing prices down to $3.60/mmbtu on Friday, July 5, 2009 at NYMEX close, down approximately 73% from the 2008 high of $13.69/mmbtu. The current low natural gas price has made it uneconomical to drill for gas wells, evidenced by more than 50% rig count drop since September 2008.

In addition, the extensive use of water and chemicals to fracture shale rocks have raised environmental concerns that hydraulic fracturing will pollute drinking water, and Congress is considering tighter regulation of the practice, which could add an additional cost to natural gas drilling and production.

Oil imports cost the U.S. about $21.6 billion in May. Increasing natural gas market share as a power source for vehicles and industrial applications means less dependence on imported oil and would strengthen America's energy independence. In the power sector, utilities have been switching to natural gas from coal, thereby taking advantage of low commodity prices and hedging against costly climate-change legislation.

However, in order to achieve a large scale of natural gas transition, there has to be a concerted and coordinated effort from both the government and energy industry. It will take a non-partisan effort to work out details like CNG transportation, taxes, and the CNG stations for natural gas to be competitive with conventional fuels. With both a thoughtful energy policy and a collaborative energy industry, natural gas definitely has a niche to fill as a substitution fuel as well as a transition from fossil fuels to renewable fuels, due to the long lead time and scalability issues of renewable fuels.

For investors wanting to participate in this market sector, gas-weighted producers like Chesapeake Energy (NYSE:CHK), and Quicksilver Resources (NYSE:KWK) could be attractive as both stocks are trading at 60% discounts to their respective estimated net asset values. But they also present a higher risks due to their substantial level of debt. On the other hand, EOG Resources (NYSE:EOG) and EnCana Corp. (NYSE:ECA) currently trading at 36% and 7% discounts respectively to their estimated net asset values, would be more conservative long-term plays in this sector.

Disclosure: No Positions