Profits From The Natural Gas Plunge

Includes: AETUF, D, DUK, ETR
by: Roger S. Conrad

Last month I noted natural gas prices were "flashing yellow" for investors. This month they've gone full-out red. That's very bad news indeed for any company with earnings that rise and fall with natural gas prices. But it's also very good news for companies that benefit from lower gas prices because of reduced costs or their ability to take advantage of greater demand.

For my investment advisory service, Utility Forecaster, I focus on high yield and safety, which means we fortunately hold many more beneficiaries than losers. In fact, even the most exposed companies in my porftolio, such as ARC Resources Ltd (OTCPK:AETUF), are holding up well to date, as other strengths are offsetting the impact of tumbling prices.

That's no small comfort here in early 2012 with U.S. natural gas prices currently at a 10-year low. Gas prices in Europe and Asia mirror oil. Meaningful gas export capacity in North America, however, is still several years off even in a best-case. What's produced here stays here. And with U.S. gas inventories 20.8 percent above the five-year average, a drop in gas to less than $2 per million British thermal units (MMBtu) is certainly possible.

Front and center among the winners of lower natural gas prices are regulated electric utility stocks. I previously highlighted the percentage change in purchased energy and natural gas costs for Diversified Energy and Energy Distribution utilities, based on third-quarter numbers. Those figures are set to decline even more in the fourth quarter and beyond.

That won't directly affect the bottom line for the vast majority of companies, as these costs are typically passed along directly into rates. Customers, however, are already seeing a marked drop in their bills, and there's more to come. That's a huge plus for companies attempting to recover capital costs in rates, which does have a direct impact on earnings.

Switching to gas affords electrics a way to immediately and economically deal with the rising cost of operating coal plants, which are being hit by a combination of rising global coal prices and tighter environmental regulation. And it reduces exposure to any prospective limits on carbon dioxide (CO2) emissions, as gas-fueled power plants emit less than half the CO2 of coal plants.

Gas-fired power plants already produce nearly twice the electricity they did in the 1990s (see "Gas' Power Move"), when independent power producers went on a building binge.

Power production now accounts for 32.5 percent of total gas usage in the U.S. And this round of demand growth is being driven by regulated utilities, a far more stable source.

Last month, for example, Duke Energy (NYSE:DUK) won Indiana regulators' OK to shut two coal plants built in the 1960s and replace them by purchasing 400 megawatts of gas-fired capacity.

That's a formula being followed by power companies across the country.

In addition to Duke, Dominion Resources (NYSE:D) and Entergy Corp (NYSE:ETR) have also expanded gas-fired power output recently.

Entergy -- which last month won a court ruling to keep the Vermont Yankee nuclear plant open -- purchased a 583-megawatt plant in Rhode Island in late December. In addition, the company's regulated Mid-South service territory is a major beneficiary of the boom in natural gas liquids, thanks to locating numerous processing facilities. For this reason, Entergy is a top pick for earnings growth.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.