I frequently read articles which talk about the "energy problem" and go on to describe how we can reduce oil imports by building windmills and how natural gas discoveries mean that our energy problems are solved. In reality, there are now two very separate energy markets and a misunderstanding of their relationship can lead to disastrous investment consequences.
To illustrate this, I am going to go back to the 1970s when I started working in the area. There was a rule of thumb then that the ratio between the price of a barrel of oil and a thousand cubic feet of natural gas should be roughly 10 to 1. Oil and natural gas were substitutes for many applications in the energy industry(including the generation of electricity and space heating) and, if prices diverged from the ratio significantly, the less expensive fuel would be substituted for the more expensive fuel and the prices would move back to the 10 to 1 ratio.
Over the next 25 or so years, natural gas gradually displaced oil in more and more of these shared markets. In the United States, there is very little use of oil to generate electricity. Natural gas replaced oil as a space heating fuel in many markets and the markets where oil is still used are generally markets in which it would be expensive to build the infrastructure necessary to get gas into the market.
As a result, the ratio no longer holds. In recent years, the ratio has moved up to the 25-35 to 1 level, making oil much, much more expensive than natural gas on a BTU equivalent basis. In the past months, the ratio has climbed to levels near 40 to 1. We have lots of cheap gas, but it doesn't make oil any cheaper at all.
Oil has become a specialty transportation fuel (at least in the United States) taking advantage of its density, ease of storage and transportation and the fact that the entire transportation infrastructure has been built around its use. Its "premium" value as a transportation fuel has made it too expensive to be used to generate electricity or to be used in new space heating applications.
As a result, the deployment of technologies designed to generate electricity will only increase oil imports in the short run as oil is used to power the vehicles used in the construction process and will not reduce imports of oil once completed. We could line the entire Atlantic Coast with windmills and the only way it could reduce oil imports is by making it impossible for incoming tankers to reach the East Coast harbors.
As the price gap between oil and natural gas continues to increase, the economic benefits of substituting natural gas for oil become greater and greater. Because oil is used almost exclusively in the transportation sector, this substitution will have to take the form of using natural gas, directly or indirectly as a transportation fuel. There are a number of ways to achieve this result; some of them may offer investment opportunities. While I cannot provide an engineering analysis of each of these, this article will provide an overview and suggest some areas which readers should continue to monitor as developments take shape.
1. Methanol - Methanol is a liquid fuel which can be blended with gasoline or, under some circumstances, used alone as a vehicular fuel. China seems to be committed to a substantial blending in of methanol in its vehicular fuel supply. By far the leading company in the area is Methanex (MEOH) which has announced plans to build a methanol plant in the United States and has plants in a number of other countries. I have written about MEOH before, and I believe that it is worth a look for investors interested in this sector.
2. CNG - Compressed natural gas is simply natural gas compressed to a smaller volume and stored in a cylinder. When my wife and I were in China, we noticed that the taxicab fleet in each city we visited operated on CNG. A big advantage is that the natural gas does not have to be converted to another duel if CNG is used. The disadvantage is that a major expenditure on infrastructure would be necessary. For this reason, CNG's most promising use is for fleet vehicles that can fuel up at one or a limited number of locations buses, garbage trucks, taxicabs, etc. Westport Technologies (WPRT) is active in this market as an engine manufacturer. Clean Energy Fuels (CLNE) is developing a national network of natural gas filing stations and is involved in other aspects of the industry. Fuel Systems Solutions (FSYS) provides equipment for both vehicles and distribution systems. Omnitek Engineering OMTK (OTCQB:OMTK) makes conversion kits to transform liquid fuel engines.
3. LNG - Liquefied natural gas is simply natural gas cooled to a low enough temperature that it takes liquid form. This compresses it to a higher density and has advantages for transportation. Some trucks can operate using LNG storage tanks, and there appears to be promise for this technology. I am not aware of any publicly traded stock which offers a strong play on this technology.
4. GTL - The technology for transforming natural gas into diesel fuel is often called "gas to liquid" or GTL. It is already deployed in several parts of the world and there will probably be plants planned for the United States. It has a huge advantage - the fuel that is produced can be readily used in existing vehicles and no major infrastructure investment is needed. The leading company in this area is Sasol (SSL). It should be noted that SSL is active in many other markets and its earnings are likely to be driven by many factors other than the deployment of GTL.
5. Electricity - This may raise some eyebrows, but the main attraction of the electric car in today's energy market is that it permits the substitution of natural gas for oil. At the margin, the lion's share of new electricity load will be met by natural gas-generated electricity. In most parts of the country, if you had to analyze what an electric utility would do differently if it had more load, the answer would be to burn more natural gas. Others have written in more detail about the likely winners and losers in this market, and I will not add to the cacophony. The one thing I will say is that the larger the gap between oil and natural gas prices, the larger the incentive to deploy electric cars.
There are no easy answers for investors here, because some of the stocks listed are clearly not "pure plays," and other have financial difficulties. I should also point out that there are other opportunities to displace oil - especially outside the United States. In places where oil is still burned to generate electricity (in the United States, this is in Puerto Rico and Hawaii; in the developed world, on many islands; in the developing world, in many, especially remote, locations), alternate electric generating technologies can back out oil. In the transportation sector, there are many opportunities to back out oil used in ships, and trains.
The big action is, however, likely to be in the vehicular fleet, and there may be some opportunities to target some very attractive investments as this transition develops.
Disclosure: I am long MEOH.
