Energy Investing: Natural Gas Looks Especially Interesting

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Includes: CHK, CVX, DVN, KWK, SWN, UNG, XCO
by: Marc Courtenay

Oil is still above $61 a barrel, and as I write this (July 16, 2009), Natural Gas has rallied over 10% in one day to $3.62 per mmBTU. I'm more than a bit suspicious about energy prices because I believe there is still a glut of supply and that "real life demand" (RLD) is dropping with each passing month.

That having been said, I'm very excited about the longer-term prospect for Natural Gas. Recently I watched an important interview on Bloomberg TV with Jason Gammel, an energy analyst with Maquarie Securities USA, which confirms other sources I have concerning both the shorter-term and longer-term probabilities with Natural Gas.

Also on the energy front, on July 10th I noticed that U.S. natural gas (NG) inventories rose 75 billion cubic feet in the week ended July 3rd to reach 2,796 billion cubic feet, according to the Energy Information Administration. Analysts at IHS Global Insight had expected an increase of 71 billion cubic feet.

At the current level, inventories were 601 billion cubic feet higher than last year at this time and 452 billion cubic feet above the five-year average.These are huge year-over-year differences, and with cooler weather in the Northeast US this summer the demand is down.

Gammel told Bloomberg that there are "huge inventories of NG and Liquid Natural Gas (LNG)". With the weak demand for NG he already sees drilling declining and he said that the "rig count" is way down from last year at this time. His theory is that by the 2nd quarter of next year that will begin to reverse the supply situation and that shortages of NG will ensue.

In the next 4 to 6 months, Gammel thought there was a high probability that NG prices could fall into the "$2s", which would cause more drilling rigs to shut down and perhaps cause a marked slow-down in production. He said that even if there was a major hurricane in the Gulf of Mexico this year he still felt that we will continue to see a huge glut in NG supplies.

This will be helpful to the economies of the world during this time of worldwide recessions, but it will also set the stage for a "big reversal in the price of NG" in 2010 and 2011. In fact, Gammel predicts that the price of NG will soar up to "the $8s" next year from the lows that we will experience later this summer and fall.

If that does happen, it isn't hard to see that NG is one of the most compelling investment themes over the next year or two, even more exciting than silver, which I believe is likely to double from whatever low is established between now and November of 2009.

Gammel of Macquarie Securities USA said he likes Chevron Corp. (NYSE:CVX) at around $60 per share, which at that price would have a dividend yield of 4.33%. It claims the share price of CVX has a 12-month potential of going up to around $84 a share.

His favorite way to play the NG investment story is Southwestern Energy Company (NYSE:SWN) which engages in the exploration, development, and production of natural gas and crude oil in the United States. The company operates in two segments, Exploration and Production, and Midstream Services.

He mentioned that SWN is big in LNG and that overall he expected SWN to increase their production by a whopping 50% this year along and another 30% next year.

Steve Gelsi at MarketWatch (MarketWatch.com) reported Thursday that "A leading investment banker looks toward more multi-billion dollar energy deals in the U.S. as bigger players take aim at hefty unconventional domestic natural gas reserves, even while energy prices remain low.

"Scott Van Bergh, head of Americas Energy Corporate & Investment Banking for Bank of America Merrill Lynch, touted his firm's role in Chesapeake Energy's (NYSE:CHK) $3.4 billion sale of Marcellus shale drilling rights to Statoil Hydro (NYSE:STO) late last year, and said similar deals may continue in 2009 and 2010.

"Overseas players from Europe or Asia may find similar asset purchases or outright mergers attractive as a way to tap into the unconventional natural gas business, Van Bergh said in a telephone interview.

"At some point, the low natural gas prices will attract some corporate mergers and acquisitions in the gas production business," he said. "We haven't seen that yet but we ultimately will."

"Van Bergh said he sees companies without significant exposure to unconventional shale plays attracted to the U.S. - still the world's largest energy markets without the political risks of doing business in less stable countries.

"Everybody believes that the natural gas industry will recover although we're in a supply glut today," Van Bergh said. "With drops in rig counts, demand will soon catch up to supply and these assets will be highly profitable. Large independent or major oil companies will need to move into the asset and the only way to get it is through a corporate merger or asset acquisition."

"He pointed out at least two other significant asset sales in unconventional gas after the Chesapeake deal: Exco Resources' (NYSE:XCO) $1.3 billion shale gas development deal with BG Group on June 30; also Quickilver Resources Inc.'s (NYSE:KWK) $280 million deal with ENI (NYSE:ENI) on May 18 for natural gas lease interests".

I personally like SWN and CHK the best in the natural gas space, as well as Devon Energy (NYSE:DVN). I have a GTC order in to buy SWN if it drops below $33. If NG did go up to the $8s in the next year or so, SWN, CHK, and DVN shares would benefit greatly, with SWN and CHK being more directly and positively impacted.

When it comes to the United States Natural Gas ETF (NYSE:UNG), I'm waiting to see if the share price might dip below $11 before I begin accumulating. In the long-run I'm hoping for a triple with UNG if we can buy the shares low enough. When the "blood is running in the streets" on NG and all the talking-heads are bad-mouthing it, that will be the time to buy.

Disclosure: As of the day I wrote this article, I don't own any of the stocks or the ETF mentioned.