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Why Enviro Politics Will Send Natural Gas Prices Higher

|Includes: AXAS, CHK, SWN, The United States Natural Gas ETF, LP (UNG)

It looks as if there may not be a climate bill passed this year by Congress. However, that does not mean that the environmentalists in the United States have lost their fight to cut coal usage.

Quite the contrary...there will be a far more rapid closing of coal-fired power generation plants in the United States over the next five years than the stock market anticipates.

That will mean one thing for sharp-eyed investors...higher prices for natural gas and natural gas stocks.


 

The Plan to Snuff Out Coal


 

Environmentalists and regulators are engaged in a multi-front war on carbon-intensive fuels like coal. If no climate bill is passed, then the opponents of coal will turn to indirect controls under existing laws.
 

They will use provisions of the Clean Air Act. In particular, the regulations covering three pollutants – sulfur dioxide, nitrogen oxide and mercury – from coal plants. The legal instrument that will be used is the Maximum Achievable Control Technology provisions of the Clean Air Act.....
 

Essentially, these provisions will require coal-fired power plants to reduce their emissions of hazardous pollutants, as defined by the Environmental Protection Agency, to the levels achieved by the best 12 percent of plants in their class.
 

Once an industry rule comes down from the EPA, each power plant has three years, with one year of allowed extensions, to bring their emissions levels down to the standard.
 

In the case of coal plants, the EPA is under a court order to issue new proposed rules for pollutants including mercury and acid gases by March 2011. The final rules would go into effect in November 2011.
 

The new regulations will 'force' utilities to install very expensive scrubbers on the smokestacks of half of all the coal-fired plants that do not have them.
 

It will not be economical for utilities to comply with the new rules and install scrubbers on most older plants. So both the utility companies and environmentalists agree that these new rules are likely to lead to a large number of coal-fired plants being closed by 2015.
 

The coal plants most at risk of shutdown are smaller generators that are more than 40 years old and without scrubbers. That is 15 to 20 percent of all coal-fired power generation!
 

That is fine with the environmentalists who see that as a preferable way to reduce carbon emissions.
 

But how do we make up for that loss in electricity power generation? The environmentalists say energy conservation. Good luck with that.....


 

Increased Natural Gas Demand


 

The common sense answer is that many utilities will turn to natural gas and add natural gas-fired power generation capacity.
 

Hugh Wynne, utilities analyst with Bernstein Research, believes the shutting down of these older coal plants will lead to an increase in natural gas demand of 10 percent by 2015.
 

So what does this mean for natural gas prices?
 

There is an assumption in the marketplace that the United States has a nearly unlimited supply of shale gas at the present price of about $4-$5 per million BTU.
 

That assumption is absolutely wrong.....
 

Many in the industry argue that without an increase to $8 or $9 per million BTU, the real costs of shale gas cannot be covered.
 

Aubrey McClendon, the CEO of Chesapeake Energy (NYSE: CHK), has said that natural gas at the current low prices is not sustainable.
 

For example, Chesapeake earns about 4 percent on invested capital while their estimated cost of capital is 8-10 percent. And Chesapeake is one of the stronger players in shale gas.
 

Ben Dell, also of Bernstein Research, believes that the full cost of finding, developing and operating shale gas wells, and paying an average return on capital to investors, requires a spot gas price of $7.50 to $8 a thousand cubic feet.
 

Mr. Dell points out that the horizontal drilling rigs needed to drill shale gas wells are in relatively short supply. He stated, “We think there will be a 15 percent to 20 percent increase in costs from last year to this year. That includes the cost of drilling and fracking”.
 

In addition, gas producers had insulated themselves from gas price weakness over the past year with hedges that are now expiring. New hedges now have to be put on at lower prices.
 

So the bottom line is that many gas producers will show declining revenues and increasing costs. Not exactly ideal conditions for producing large amounts of extra natural gas that utilities will be demanding.


 

Natural Gas Companies


 

The inevitable answer is that natural gas prices will have to rise so that enough is produced to meet the increased demand. This bodes well for US natural gas producing companies.
 

One large natural gas producing company in the United States is the aforementioned Chesapeake Energy, which is a leader in natural gas production from shale rock.
 

Another large natural gas producer is Southwestern Energy (NYSE: SWN) which produces a lot of natural gas from the prolific Fayetteville shale gas field. It also has one of the lowest production costs in the industry.
 

For investors looking for a small-cap play, there is Abraxas Petroleum (NASDAQ: AXAS). It is one of the 10 best-performing oil and gas production stocks year-to-date. It is up 55 percent since the beginning of the year and up more than 230 percent over the past 52 weeks.
 

Abraxas has exposure to some of the most prominent shale gas plays in the country: Bakken, Haynesville, Barnett and the Permian Basin, among others.
 

As always, investors are urged to do their due diligence before investing into any company.


 



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