Investing in Natural Gas: It's Time

Includes: BHGE, FSYS, UNG, USO
by: John Dalt

Natural gas has been in the news for the last few months as supply has outstripped demand. Natural gas is now under $3 mcf, which is a multi-year low. Jimmy Carter declared over 30 years ago, “The U.S. is running out of natural gas.” Fast forward and gas is now cheaper than coal for generating electricity. Shale gas has been exploited with new drilling technology.

If you liked natural gas producers when gas was over $10 mcf, what's not to like about $3 mcf natural gas? Many newsletter writers have pushed the natural gas play since last spring. I believe the time has arrived. We are coming up on winter, and natural gas is poised to heat millions of homes. The economy seems to be recovering, and natural gas is the energy that supports manufacturing. One other use in natural gas's favor: transportation.

Last year, T. Boone Pickens pushed natural gas in the “Picken’s Plan” to wean the U.S. off foreign oil. He made some headway before the collapse in the crude oil price. Well, crude oil and gasoline prices are headed back up. Last year, Fuel Systems Solutions, Inc. (NASDAQ:FSYS) hit $61 per share when $4 per gallon gasoline prices had a chokehold on Americans.

FSYS sells meters and valves that let your car, pickup or bus run on compressed natural gas. There are no internal modifications necessary. Just add a tank, valves and meter in front of your car’s fuel intake and you can drive for less than $1 per gallon. You also need a compressor at your home to fill the car from the natural gas line that supplies your house. Guess what? No road taxes. A great way to beat the government!

FSYS is at $32 as we write; UNG (the natural gas ETF) is at multiyear lows. Below is a comparison chart of light sweet crude vs. natural gas. The ratio is stretched almost triple the normal relationship. Oil may get cheaper, gas is so cheap producers may begin to withhold production.

Oil vs GAS

If you believe that all markets return to the norm over time, this chart should give you some idea of the extreme conditions that now exist in the cost of energy from these two sources. The historical ratio looks to be about 8 to 1; we are now sitting at 21 to 1. When a market gets this far out of the normal range, the likely result is a snap back to the historical relationship. Many times the momentum will overshoot the target. I would rather be long natural gas, at these prices, than crude oil.

According to the Energy Information Agency (EIA), we imported approximately four tcf of natural gas last year. Ninety percent of this imported gas came from Canada. Most of this natural gas comes from the Western Canada Sedimentary Basin, where production peaked in 2001. Production has decreased 8.1% since then. Natural gas well production declines much quicker than crude oil. It takes constant exploration and discoveries to replace the depletion. According to Baker Hughes (BHI), a drilling company, there are 688 rigs drilling for natural gas in the U.S. That is 56% less than a year ago. This is the future we face: natural gas is abundant, but we are not replacing the reserves to meet our future needs.

Two other points need to be made concerning natural gas. Reports are that natural gas short interest is running 2 to 1 against long positions. There is no fuel for a rally like short covering! On Friday, rumors circulated that a major hedge fund had taken a huge long position in natural gas.

Our recommendation is to get long FSYS and/or UNG, I like the odds on both of these. One is an investment the other is a trade. Either could make you 50% or more in the next six months.

According to the Peterson Foundation, government debt stood at $184,000 per person in 2008. That adds up to $920,000 for my family of five. I sure am glad our oldest daughter graduated from college last year and is on her own. With the spending this year, we are over a million already. Hold onto your wallet, taxes have to go up.

Who will pay it? 43% of all taxpayers owe no taxes, so it is left to the rest of us. This means you have to pick up their share too. So add another $79,120 to each citizen that PAYS taxes for those that do not pay anything. We add another few billion to the national debt EVERY DAY. With Oh! Bama’s promises not to raise taxes on anyone but the “wealthy”, the only way out of this financial pickle is inflation. Inflation like we have never seen before.

It is laughable to hear Fed Chairman Ben Bernanke talk about maintaining the value of the dollar. The only value the dollar has is the weakness of other currencies. It is like a game of one-upmanship. The U.S. makes stupid decisions, Britain does us one better. Countries are racing to devalue their currency for short-term competitive advantage in trade, and to cover up past mistakes in interest rates and lending.

"There are 100,000,000,000 stars in the galaxy. That used to be a huge number. But it is only a hundred billion. It's less than the national deficit! We used to call them astronomical numbers. Now we should call them economical numbers"---Richard Feynman (1918-1988)

Richard, rest in peace. Oh! Bama and Congress call them rounding errors.

Disclosure: Long UNG, Short USO