Oil and Natural Gas Will Decouple - Big Time

Oil and Natural Gas are typically welded at the investment hip. They often occur simultaneously in developed fields and are lumped together in much the same way as physical gold and silver - ratios of one to the other are viewed historically and investibility in either looks attractive when those ratios are either high or low.

I'm going to offer an alternative view. Consider oil and natural gas as different bridges, of limited life-spans, to the future. Oil's bridge was built generations ago. It lifted early industrial, fuel powered societies thru an assisted muscle powered age to a decidedly unmuscled technological age. While there are still decades of diminishing supply left it is the fuel of the past. Literally, that bridge has been crossed. Natural gas will, of necessity, carry us over a shorter time span to the next energy bridges, most likely some version of much cleaner coal, nuclear power, and wind/solar power. Even those future generation sources will not be final answers, but in investing, final answers are not necessary. Only profitable ones.

Three factors are critical for Natural Gas.

1. The sources must be local in a broad sense. Pipelines are local. LNG is not.

2. The sources must be secure geoplitically and they must depend on an extensive, well constructed and maintained infrastructure.

3. The sources must currently be extensive enough to be depended on for reliable near supply, and the greater geographical area promising for some future development of reserves.

Look to some of the following to provide reliable current, and reasonable future, returns.

1. Natural Gas Services (NGS) and Grant Prideco (GRP)/ National-Oilwell Varco (NOV) for the nuts and bolts of gas delivery.

2. Energy Products (EPD) for fractionation (Natural Gas refining and breakdown) and transport, BlackRock Global Energy & Resources Trust (BGR) for a broad based safe haven closed end fund that gives a diversified portfolio of gas infrastructure equities at a 10% plus discount to NAV.

3. Linn Energy (LINE) and Penn West (PWE) for long term reserve production and dividend streams. Natural Gas is going its own way..and it will be a highly profitable one.

Disclosure: I have, or have had, positions in all of the above. I wouldn't recommend anything that wasn't worth my own money.

Comments

[erniem:]

I have similar sentiments. A clean burning, available energy source that is cheap to transport and available in the US is not going down in value. While gas is used primarily for heating and power generation, and oil supplies most of our gasoline, improved efficiency in cars will lower oil demand slightly, neither power needs nor heating are going away, only growing.

2008 Feb 22 09:23 AM

[Greg Pinelli:]

Ernie..this is Greg Pinelli the GeoRealist....your observations are accurate. Another kicker for nat gas is that it fuels a considerable portion of the electrical grid...and between now and peoples fantasy fuel of the future we'll likely get the plug in hybrid or just straight plug ins. In two years we'll look back at Nat Gas at $8.00 much like $12.00 oil....long gone and the bargain of a lifetime.

2008 Feb 22 09:33 AM

[ellwodo:]

I certainly agree with the premise, but in getting to the conclusion what happened to DVN? It seems a perfect fit to your parameters.

2008 Feb 22 11:33 AM

[jack kreg:]

Have you compared the economics and environmental issues between natural gas and liquified coal fuel. I have heard that LCF is much cleaner than burning pulverised coal, the toxic compounds (mercury and sulfur) are removed in refining. The fuel must be something like a heavy crude oil? The cost maybe high, making it economical with foriegn oil at $100, but maybe it is worth the cost, if we can reduce imports of foriegn oil. Any other facts or comments. One also has to look very hard at nuclear power, and its use in the power grid and for battery powered electric cars. thanks for article, I am an owner of EPD (gaslines), ERF and PGH (oil and gas Canadian trusts), and a buyer on dips to support.

2008 Feb 22 11:53 AM

[Greg Pinelli:]

Ellwodo and Jack..Greg Pinelli here. Devon is fine..LINE actually acquired some of Devon's properties. My objective in highlighting PWE and LINE is that they are the most aggressive of their particular groups (Canadian Ryalties and Publically Traded Partnerships respectively). Liquified will probably fit into the equation somewhere..the problem is there are greater political hurdles due to environmental concerns than for anything else...although concerns over nuclear power are a close second. It should be pointed out that many Asian countries are developing nuclear plants at an incredible rate. When the time is right watch for a political about face....how about when oil is $175 and Nat Gas $25!

2008 Feb 22 08:49 PM

[John L.:]

Now that the oilsands companies in Canada can produce effectively due to the higher cost of oil, guess what they will be using to heat up the slurry to drive the oil out of it, you guessed it, Natual Gas, which is a lot cheaper and more plentiful than any other means. Will this drive up the price, you bet!!

2008 Feb 23 02:48 PM

[bsharvy:]

Other natural gas plays: XEC and BDE. COP and STO have bigger bets than the other integrated big palyers. PWE is about 55% oil.

2008 Feb 24 03:15 AM

[User 155228:]

Folks,
What are your thoughts on PetroHawk Energy Corp (PHK)...?
They recently acquired KCS Energy.
Tommy

2008 Feb 24 08:43 AM

[GKM:]

As John L. says the drive for more oil sands production will have a substantial impact on the use of natural gas. I would be particularly wary of some oil producers that are building oil sands production that uses nat gas and that have not hedged their exposure to that key input. Oil sands production for those processes makes sense when the ratio is 9:1 but not nearly so much when it is 6:1 or less (6:1 being a long term historical average for the gas to oil ratio). There are a few companies working with less nat gas intensive technologies and those are the ones you should seek out.

Down the road, perhaps methods for methane hydrate harvesting will be workable to supplement dwindling nat gas reserves.

2008 Feb 24 12:17 PM

[gloria1234:]

Thanks to all S alpha OG commenters for yr recommendations. Here's mine: I have earned 23% on DAYYF.PK, a Canadian og trust, for my IRA, since 08/2007 purchase--like it! Great div.

2008 Feb 24 01:52 PM

[guyguyette:]

I am surprised no one has mentioned APA. Granted they have oil interest as well.

2008 Feb 24 02:21 PM

[Barry Robbins:]

China has a major air pollution problem, that will be obvious to the world during this summer's Olympics. With this in mind, I recently bought SinoEnergy (SNEN.ob). They own natural gas filling stations in China.

2008 Feb 24 04:02 PM

[Kunst:]

Oil and natural gas are more different than people sometimes think. Yes, they are both energy sources, and tend to be found together. But their uses couldn't be more different. Natural gas is primarily turned into electricity, while oil is used almost exclusively for transportation. There are a lot more alternatives for the former than the latter.

2008 Feb 24 09:12 PM

[Turley Muller:]

I think oil/gas have ready decoupled. The ratio is 11 to 1, with the longterm avg ratio being 6:1, with some people opining that 8:1 is reasonable.

NG demand and usage will definitely increase. Your bullet points- NG fits them, local, developed infrastructure, abundance, non dependence on terrorist nations.... It's also clean. Yet, NG is mostly used for utilities. I can't ever envision engines running on NG, I'm sure it could be converted into some type of engine fuel, at a high cost, similar to alternative fuels. We could use more NG in power by replacing coal and heating oil plants. I think that will be a trend.

CHK is a great NG company, largest DOM producer (or about to be) of gas. see this article I wrote:

seekingalpha.com/artic...

2008 Feb 24 10:16 PM

[viv:]

GGR - Geo Global Resources is also a speculative "must own" . Soon to release official reserve numbers for their part ownership a the giant Indian gas fields discovery, also in India they have Oil.

2008 Feb 25 12:22 AM

[Eileen W.:]

The energy sector is a back to basics play. I have successful investments in Penn West Energy Trust (PWE) and Golar LNG Ltd (GLNG) over the past few years and intend to keep them. I recently added Evergreen Energy Inc. (EEE) to the mix because this company not only owns coal mines but has cost efficient refining technology that removes the mercury and sulfur elements. This enviro process can be set up at the coal mine or at the end user's facility (i.e. electrical power plant) anywhere in the world (think exploding markets in China and India). Coal shipped in from anywhere can be cleaned up before it is burned in the plant. The refining process uses energy generated from the power plant to clean up the coal. In America, this means that our coal mines continue to operate in both the eastern and western states. This nation can further reduce its dependence on Middle Eastern oil to fuel our economy and retain jobs at all levels of the industrial supply chain.

2008 Feb 25 02:25 PM

[Greg Pinelli:]

Hello..this is Greg Pinelli..the GeoRealist. Thanks for all you insightful comments. My objective in the next few postings will be to provide you with a different way of looking at things. The only real way to make money investing is to think differently..and that, hopefully, can be advanced here.
Please watch oil sands..oil shale..especially in Alberta very closely. Alberta is becomeing a very environmentally activist province..and the least of the oil sand..tar sands problems will be plentiful nat gas. Water is critical..that without which nothing is possible!

2008 Feb 25 09:45 PM

[OilTrader23:]

Just wanted to chime in that PWE is at the top of my "recommended energy trust list" and I own a postition in it after getting switched over as a CNE holder.

I have CNQ listed as the #1 pick in the straight stock realm. It's value and potential are still overlooked, even with latest run up. Price target on it is $103 here by end of 2008.

2008 Feb 28 04:05 PM

[rpj:]

Thanks to all for the comments. Take a look at GMXR. A father and son run company who put their money where their mouth is.
If they were shooting fish in a barrel I don't think they could do any better. Check out their drilling success rate. BTW....Auto's can run on NG with a conversion kit installed for a couple of grand. Go NG.

2008 Mar 02 01:36 AM

[Bruce Pile:]

Global natural gas is projected by the Hubbert model to keep climbing briskly to a production peak around 2030 as opposed to a precarious plateau for conventional crude. Thus it appears to be about a 30 year bridge away from crude to the fuels that will follow. LNG will continue to become a vital survival fuel to most nations while in the U.S. LNG continues to be a boogey man. Our measly 3% use of LNG will come in real handy when North American production collapses. This will not be a gradual decline like oil. Gas fields fizzle much more quickly and with much less warning. Natural gas will be decoupled from crude as a fuel of the future around the world, but in the U.S. it will be just another dunce cap our energy policy will have to wear.

2008 Mar 04 02:38 PM

[Pasoman:]

I fail to understand why LINE (stock price) is going down, down, down. When the continue to accumulate larger and larger reserves?
I figured, apparently wrong, that as oil climbed over $80/bbl that natural Gas would also rise because Oil Burning Power stations would convert to natural gas because it was a cheap way to get out from under the pressure of the environmentalists and the price point of oil.
What happened, LINE is headed for the basement?

2008 Mar 13 01:52 PM

[Dan Notestein:]

I believe the market's negative take on LINE is because of it's long term hedges of around 85% of it's oil (6 years) and nat gas (5 years) production. These long term hedges look even worse on their books, because the 5 years of losses due to increasing prices show up immediately on their books all at once, whereas their presumed profit from the increased prices doesn't get accounted for until they actually produce it.

2008 Mar 13 10:20 PM

[User 166665:]

It is interesting to read your observations. It's clear that oil and gas have decoupled. We all know that it takes 6 mcf of gas to provide the energy equivalent of 1 bbl of oil. But oil is over $100/bbl, and gas is not at $16.65/mcf.

But remember one thing: We use the same drilling rigs, the same casing, the same valves and fittings and the same cementing and fracturing services to drill and operate a gas well as are required to drill and operate an oil well. So the cost of developing existing gas reserves to replace what we are currently producing will increase, and that will drive up gas prices. I doubt that we'll see parity, as supply and demand won't support that, and the two commodities are transported and stored quite differently. But increased demand for oil drilling will drive up the price of natural gas. Bet on it.

As a (very) small Appalachian natural gas producer/operator, I marvel at the Linns and Chesapeakes of the producing world. While they enjoy certain economies of scale, their significant overhead more than offsets the benefits they enjoy by being big. And they pay premium prices for properties they buy. Small producers are much more efficient. Their costs of finding, developing and producing natural gas is far less than that of the big pubic companies. Remember: there are two ways to make money in the oil and gas business. The first, is by selling oil and gas at profit. That's what small producers do. The second is by seling oil and gas deals. The public companies are generally in the second category.

The big boys love to chase the elephants. But not all of these plays will be successful. For example, in my opinion, the jury is still out on the Marcellus Shale play in Appalachia. (Remember the Trenton and Rose Run play, and where that led?). And yet these big companies are risking a bundle on the Marcellus. We'll see how that works..... For technical reasons, I have my doubts.

In order to feed their demand for human resources, the "big boys" are hiring every available warm body, paying premium prices, and offering excellent benefits. And where do those costs go?

For a seasoned veteran (okay, I am old....) that has worked the Appalachian gas fields since the 70s and observed the booms and busts (and changes in the regulatory environment), these are truly interesting times!

2008 Mar 21 02:29 PM

[User 302947:]

Hey I am interested in this too, but most gas prices are indexed to oil via the contract mechanism from what I understand, even if the fundamentals are different, is there any evidence that this will change. Also from a technical point has anyone seen any parameter instability?

2008 Nov 20 08:37 PM