Natural gas's abundant supplies and low prices are having a dramatic effect on how we generate electricity. The biggest price drop in over a year, coupled with the prospect of stringent pollution legislation, has eroded the market for coal and caused natural gas to move up the energy food chain. The Department of Energy estimates that gas-fired electricity will climb nearly 31% in 2010 - up from five years ago, while coal usage will fall 6.5%. This fundamental shift in energy production can mean big profits for longer-term investors.

IN PICTURES: 5 "New" Rules For Safe Investing

The Big Switch

The lowest natural gas prices in over 11 months, combined with an unfavorable regulatory outlook toward coal, has prompted many utilities to defer new coal projects and construct plants that burn the cleaner choice. According to the U.S. Energy Information Administration, coal-fired plants are expected to fall to just 10% of total new capacity in the United States by 2013, down from 18% in 2009. Natural gas, however, is expected to climb to 82% of new capacity in 2013. Executives at utility Duke Energy (NYSE: DUK) predict that as long as natural gas prices hover between $4 and $7, there will be a continued shift toward natural gas-fired plants.

Other power generators are following suit. Xcel Energy (NYSE: XEL) recently announced that it wants to convert a Denver plant to burn natural gas instead of coal. The utility expects to save $225 million converting to gas rather than installing pollution equipment on the coal units. Progress Energy (NYSE: PGN) has plans to close four coal-burning plants and replace two of them with natural gas by 2017.

More and more utilities continue to shift away from coal toward natural gas. These new and converted plants will help create a floor for natural gas prices and ultimately benefit natural gas producers in the long run.

A Gas-Fired Portfolio

Coal is still the leading fuel in power, accounting for about 47% of electricity generation. Investors shouldn't abandon the Market Vectors Coal ETF (NYSE: KOL) just yet. However, over the longer term, this shift toward natural gas could be one of the better investment themes. Investors may want to position themselves accordingly to profit.

Several of the major integrated oil companies have signaled their natural gas ambitions; for example, Exxon Mobil (NYSE: XOM) with its recent purchase of XTO Energy. Both the First Trust ISE-Revere Natural Gas (NYSE: FCG) and Energy Select Sector SPDR (NYSE: XLE) count some of the largest oil and gas firms as their holdings. These firms will most likely be the long-term winners as more natural gas is used to generate electricity.

Inversely, investors may want to stay away from the small fries as new fracking legislation could price many of these smaller firms out of their lucrative shale formations. Investors may want to avoid the Jefferies TR/J CRB Wildcatters E&P (Nasdaq: WCAT), which focuses on small cap natural gas firms.

Finally, betting on natural gas prices via vehicles such as United States Natural Gas (NYSE: UNG) has been mediocre at best. A better way is to invest in natural gas infrastructure via the UBS E-TRACS Alerian Natural Gas MLP Index ETN (NYSE: MLPG). The ETN focuses its attention on storage and pipeline opportunities in the sector.

Bottom Line

With its low prices and pending legislation affecting its major competitor, natural gas is once again seeing its star rise. More and more utilities are beginning the shift away from coal-fired plants to those that use clean natural gas. As this shift continues, companies involved in its production will benefit. Long-term investors can profit from this by placing their bets now while prices are still low. (For related reading, see Mine For Profits With Natural Resource Sector Funds.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  2. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  3. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  4. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  5. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  6. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  7. Chart Advisor

    How Are You Trading The Breakdown In Growth Stocks? (VOOG, IWF)

    Based on the charts of these two ETFs, bearish traders will start turning their attention to growth stocks.
  8. Mutual Funds & ETFs

    Pimco’s Top Funds for Retirement Income

    Once you're living off the money you've saved for retirement, is it invested in the right assets? Here are some from PIMCO that may be good options.
  9. Chart Advisor

    Watch This ETF For Signs Of A Reversal (BCX)

    Trying to determine if the commodity markets are ready for a bounce? Take a look at the analysis of this ETF to find out if now is the time to buy.
  10. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
RELATED FAQS
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center