Filling Up on Natural Gas

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 |  Includes: CEO, COP, DVN, MUR, UNG, VLO, XEC
by: Devin Brady

Steady as she goes--the energy complex continues to climb with no end in sight. Foolish mandates for ethanol will continue to send the energy sector higher-- much, much higher.

Within the energy sector, natural gas seems to be the most undervalued commodity. Over the past two years, crude, heating oil and gasoline futures have climbed between 60-85 percent higher. In comparison, natural gas has gained only about half as much at about 40 percent.

Most recently, natural gas has begun to narrow the spread by rallying significantly. I expect this trend to continue as the laggard in the energy sector becomes the leader.

click to enlarge images

Where's the demand?

Beyond the obvious demand for energy commodities, there are a couple more factors for why I believe the demand for natural gas will increase. The first reason has to do with the fact that natural gas is the cleanest of all the fossil fuels, producing about half as much carbon dioxide per unit of energy as coal and is primarily composed of methane. The main bi-products of natural gas are carbon dioxide, and water vapor, the same compounds that we exhale when we breathe.

Electricity Generation

Because natural gas is more eco-friendly it has emerged as the fuel of choice for producers of electricity through the use of gas turbines and steam turbines. More than 90% of electrical generating plants built in North America since 1990 have been natural gas fired plants.

Source: EIA

The Ethanol Effect

The global fascination with ethanol has played a major role in the record levels for the CRB index. Ethanol mandates from countries like the United States, Australia, Canada, and Brazil, have resulted in huge demand of not only corn, and soy, but for natural gas, and fertilizer as well.

The United States has about 116 ethanol distilleries, with 78 plants under construction and seven undergoing expansion. The 25 percent increase in last year's ethanol production will look like a drop in the barrel unless the government wakes up--good luck with that.

Over 90 percent of U.S. ethanol plants are using natural gas boilers because they are seven times cheaper than ones that burn coal. It takes about 30,000 BTU of natural gas to produce a gallon of ethanol. Therefore, a 50 million gallon per year ethanol plant consumes about 5 billion cubic feet of natural gas.

The increase in natural gas demand from ethanol is not limited to the broilers but includes a huge increase in global demand for nitrogen based fertilizers. With global grain prices soaring farmers are increasing the amount of fertilizer they use in order to maximize their yield per acre. Manufacturing 1 ton of anhydrous ammonia fertilizer requires 33,500 cubic feet of natural gas.

Source: EIA

Natural gas consumption in the U.S. increased by about 6 percent in 2007, according to the Energy Information Administration, and is expected to increase between 2 to 6 percent going forward. With the increase in demand from ethanol and in electricity generation expect the demand to far surpass government estimates.

Who's got gas?

What about supply? Production of natural gas in the U.S. has remained relatively flat over the past 40 years. In 1960 we produced 20,698,240 mmcf, and in 2006 production was at 19,381,895 per mmcf. The number of rigs exploring for natural gas in the United States is nearing a 25-year high but production has remained flat.

The average production from a North American natural gas well is continuing to decline. A gas well that went into operation 10 years ago is producing about 70 percent less gas then at their peak.

The combination of increasing demand with stagnant supply--well you know the rest.