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A Natural Gas "OPEC"? It Will Never Happen

Major natural gas exporter Algeria recently lobbied for OPEC style production cuts in hopes to address the global supply glut and raise weak natural gas spot prices. Is a natural gas equivalent of OPEC in the cards? Not in your lifetime.

The problem Algeria faces is quite simple: the world is awash in natural gas. Huge natural gas supply is now, and will be coming on stream, from all over the world: Australia's coal seam gas, StatOil's (NYSE:STO) Snohvit LNG project  http://www.upstreamonline.com/live/article212423.ece , ExxonMobil's (NYSE:XOM) huge LNG project in Qatar
http://www.exxonmobil.com/Corporate/news_features_20081231_qatar_lng.aspx
, as well as Iranian and Russian supply just to name a few examples. Best of all for United States are the prolific American shale plays and the technology needed to economically bring that shale gas to market. This is the wonderful news about natural gas: there is no possibility of an OPEC style cartel to control prices because the world has a very diverse set of suppliers. It is because of this abundance of supply and because of large LNG capabilities coming on-line which will enable world-wide delivery of natural gas that prices will remain low for decades into the future.

As I have written on Seeking Alpha before: I believe the historical oil-to-natural gas ratio has been changed forever. The ratio is currently over 20, about double the average since 1995 (9). Many natural gas consuming countries have made a huge mistake by linking natural gas contracts to on oil-index. This is a huge error and shows a basic misunderstanding of the fundamentals of oil and natural gas economics. In the coming years, worldwide oil supply will have much difficulty keeping up with worldwide oil demand while the exact opposite is true of worldwide natural gas supply and demand, It doesn't take a rocket scientist (let alone an economist...) to figure out this means higher prices for oil and low and stable prices for natural gas.

Yet the biggest error in judgment has been made by U.S. economists and energy policy "experts" like Energy Secretary Chu. Despite huge staffs of highly paid "professionals", these folks have been unable to figure out the energy basics described above. Their inability to figure things out is mystifying considering 2008's $145/barrel high, current oil prices over $80/barrel, and natural gas going for $4/Mcf. So what's their problem? Since the economics are obvious, natural gas is cleaner, and the supply is domestic(!), the problem must be political. How sad is that? As a result, legislation like HR 1835 remains moth-balled in Congress and the obvious solution to the economic, environmental, and national security issues America faces as a result of its addiction to foreign oil (natural gas transportation), has not been adopted. Worse still, the oil crisis we have experienced and still face has not resulted in an American strategic long-term comprehensive energy policy like this:
http://thefitzman.blogspot.com/2008/08/strategic-long-term-comprehensive-us.html

In spite of these serious lapses in energy policy, no one (other than me) seems to be calling for Energy Secretary Chu to resign. He should do so - preferably today.

What does this mean for investors? Obviously my take is that the American economy will again be racked by much higher oil prices and gasoline prices. Logically then, an investor should have significant exposure to oil investments while at the same time being out of broad market investments like the S&P500. While smaller oil producers highly leveraged to oil prices and more likely to be bought out are perhaps the best way to play it, I also like the large oil producers that pay nice dividends: StatOil (STO), BP, Chevron (NYSE:CVX) and Conoco Philips (NYSE:COP) come to mind. Occidental Petroleum (NYSE:OXY) is more highly levered to oil prices than any of these and deserves consideration albeit its devidend is less attractive. A more speculative stock is Brazilian company Petrobras (NYSE:PBR). However, the proven large reserves will mean the biggest increases in oil production of all the previously mentioned companies. For this reason, PBR is worth the risk. Buy PBR anywhere below $45/share and you won't be sorry 3-5 years from now.

Disclosure: Long BP, COP, PBR, STO