Natural Gas Stocks: The Ultimate Form of Stored Solar Energy

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Includes: CHK, CP, ECA, FCG, IMO, XOM
by: Joseph L. Shaefer

I have made the point in previous articles that natural gas, oil and coal are like giant batteries that nature has provided. They are the ultimate form of stored “solar” energy.

To over-simplify for explanation of this perspective, if it were not for photosynthesis courtesy of the sun, plants could not grow and thrive and most species of animals could not live. If plants and animals had not lived and then died over the eons of pre-recorded time, giving up their water and leaving behind their carbon, there would be no fossil fuels. Centuries and millennia of compacting the remaining carbon in these life forms created these giant batteries for our use.

Most folks today, looking for something new and exciting in energy, find fossil fuels boring, passé, dirty and/or the sole factor in global warming (anthropogenic, or “man-caused” global warming.) I’ll take on the latter group in next week’s lead article but, for now, suffice it to say I think these people are seeking the ephemeral and the unproven while eschewing the wondrous gift countless quintillions of dearly departed living organisms have already left for our use.

Like the wishers, hopers, and true believers of the solar religion, I, too, wish we could rely on collecting the sun’s rays and the wind (which the sun effectively creates) exclusively. We can’t. Get over it. Use The Force, Luke. Use the batteries.

That brings me to the question, “Which of the giant batteries provides the highest mass energy while releasing the lowest hydrocarbon content as a by-product?” I conclude that it is natural gas. This is really fortunate for America since we have enough natural gas to last 300 million people for 100 years -- while we are finding smarter ways to collect the diffuse rays of the sun and use them the same day or week received rather than having to wait a few million years to benefit from them as stored energy.

I’ve already discussed the dynamics of where this natural gas is located, and suggested readers take a look at the First Trust ISE-Revere Natural Gas Index Fund (NYSEARCA:FCG), in the partner article to this one (here.) I promised in that article that I would suggest some companies that will benefit the most if America does the smart thing and uses the “batteries” here at home just waiting to be inserted into power plants, rather than prop up an endless stream of corrupt dictators, tyrants, oligarchs, emirs and sheiks on distant shores with a not-so-endless stream of US dollars.

Among my favorite exploration and production companies in North America are:

Imperial Oil (NYSEMKT:IMO). I first started buying Imperial Oil 11 years before I started writing Investors Edge ® and I’ve been publishing IE for 19 years! The first time I bought IMO I did it because the company was (and is) Canada’s oldest and biggest oil company with operations in all sectors of the industry, from exploration and production to refineries and gas stations. I figured Exxon (NYSE:XOM) was going to buy the remaining percentage of the stock it didn’t already own. (XOM owns 70% of IMO.) Now I only hope XOM never buys them out because we can make a lot more money with IMO as a separate company!

At the current rate of production and consumption IMO has 140 years worth of proven oil and gas reserves, without ever drilling another new well. They are focusing on oil sands and natural gas now. And Canada still has massive -- miles and miles and miles -- amounts of land that no one has even surveyed for possible mineral and energy resources. But with IMO and parent XOM’s deep pockets, you can bet IMO is tying up as much as they can.

In oil sands alone, Canada has as much oil as Saudi Arabia. The Saudis can get it out of the ground for about $3 a barrel. It costs the oil sands miners/drillers more than 10 times that amount. Still, it would be great to see the Saudis have to compete on price and “only” make 1000% on their oil sales to those nations that must have it shipped via Very Large Crude Carriers rather than simply pipelined between the two nations with the longest friendly border in the world.

Encana Corp (NYSE:ECA). I’ve owned Encana since before it was known as Encana. Back in the day, I bought shares of PanCanadian Energy (was PCX). PanCanadian was a company created by Canadian Pacific (NYSE:CP), to this day my favorite railroad stock. CP was drilling a well for water in 1883 near what is now Medicine Hat, Alberta and struck natural gas instead. Welcome to Canada! The new oil and gas exploration subsidiary they created ultimately became PanCanadian which merged in 2002 with Alberta Energy to become Encana.

While IMO is the biggest oil and natural gas company in Canada, ECA is the biggest natural gas company in Canada and, indeed, in all of North America, with more than 80 percent of its production in natural gas. As the largest natural gas producer on the continent, they produced 1.4 trillion cubic feet of natural gas in 2008. Both IMO and ECA are incredibly conservatively-managed, solid-balance-sheet, and intelligently-hedged companies that befits their age and experience.

Chesapeake Energy (NYSE:CHK). Finally, the relative newcomer, both for me and compared to the other two, is Chesapeake Energy. CHK is one of the biggest natural gas producers in the country but what I really like about them are two things. First, they are the most active driller of new wells in the U.S., which I believe will see far more discoveries in the shale trends than will Canada. And second, while they develop both conventional and unconventional natural gas reserves, their focus is primarily on developing the "Big 4" natural gas shale plays: the Barnett Shale of north-central Texas, the Haynesville Shale of East Texas and northwestern Louisiana, the Fayetteville Shale of central Arkansas and the Marcellus Shale of the northern Appalachian Basin. (See previous article for a map of all these.)

I personally believe, based upon the historical evidence of oil and gas deposits in North America, that a lot more dinosaurs gave their lives here than the well-Gored “Oh, golly, we’re all out of fuel” types believe. I think we have just begun to scratch the surface, no pun, of these deposits, and there’s Chesapeake, leading the charge.

My most desirable entry point for IMO would be between 25 and 30; for ECA between 35 and 40; and for CHK between 12 and 17. All are higher now, so we’ll take very small positions, looking to add via rare-for-us limit orders as /if prices decline.

I need to address, and you need to decide before you invest, if two camps of naysayers are correct. If they are, I could be all wet in my embrace of sun-created carbon fuels in general and natural gas in particular.

First, those who misunderstand and misrepresent “Peak Oil” believe we are running out of fossil fuels at an alarming rate and we’re all going to freeze in the dark unless we massively subsidize renewable energy sources and put not another nickel into tapping the giant batteries.

In fact, M. King Hubbert (an American geologist) proposed in 1956 that fossil fuel production in a given region and over time would follow a bell curve. Hubbert noted correctly that after fossil fuel reserves are discovered, production is great at first as extraction begins and the latest state-of-the-art facilities are installed. At some point, a peak output is reached, and production begins declining. But he made no prediction as to how technology would allow us to find ever more fields not available to us given the technology at a particular point in time.

I do not suggest that the world’s reserves of oil are endless; merely that we haven’t a clue what’s out there until we can find a man with x-ray vision who can see well into the earth’s crust and upper mantle.

The other argument against natural gas is that, at least right now, gas is going to $1 per MMBtu, that all natural gas storage facilities are already taken up and drilling for more will only add to the glut, and that natural gas companies are leveraged in such a way that they cannot survive a period of no drilling and no sales.

Not true. The spot price of nat-gas may go to $1 tomorrow. Or it may go to $3. I don’t concern myself with endless speculation of things I cannot predict and doubt others can, either. What matters is that the three companies I favor all have hedged somewhere between 55% and 85% of production at prices between $3.50 and $5.00 per MMBtu. Utilities and other users of nat-gas don’t want to be on the wrong side of a plummeting or skyrocketing fuel any more than the producers do. That’s why they lock in contracts at what they, between producer and end-user, think is a fair price.

The contango in nat-gas is strong. Spot may be $2; for February delivery, just 5 months away, it’s $5.03 per MMBtu. Finally, these companies are not so highly leveraged that, as one commenter stated in a post at my previous article, all natural gas firms were being shorted by all the hedge funds because they were all going bankrupt. IMO and ECA are rock-solid and can withstand short periods of no sales or unprofitable sales; CHK a bit less so but I still don’t see serious problems developing with them.

Having taken so much time to deal candidly with the “other side” of the argument, I’ll now wait to provide my picks among the pipeline companies until I return from a camping trip on Thursday.

Until then, Good Investing!

Full Disclosure: We are long pilot positions in FCG, ECA, IMO and CHK.

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
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