Natural Gas: A 10-Year Makeover For The Energy Sector

By James Brumley | December 07, 2011 AAA

There's a major undertow developing in the energy sector, though it's so big it's almost imperceptible. If you've got about 10 years though, it could reap outsized rewards for a holding period of that time. Seriously.

The undertow is the looming advent of natural gas as a primary means of producing energy.

It's not a new idea, obviously. Companies ranging from pipeline owners like Enterprise Product Partners LP (NYSE:EPD) to utilities like El Paso Corporation (NYSE:EP) to crude oil icons like ExxonMobil (NYSE:XOM) have all had their hand in natural gas for a while now. And, they'll all do well as a result of the coming change. What's coming, however, is bigger than just a measurable bump for a few companies - it's a paradigm shift that could change the way investors value the energy sector.

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Hello Natural Gas, and Move over Oil
It would be an overstatement to imply crude oil is going away. It isn't. Natural gas is going to become a much bigger part of the energy picture in the United States though.

While huge oil discoveries at the Bakken fields of North Dakota and more recently at Eagle Ford in Texas have captured the hearts and minds of investors, their smashing success has obscured the fact that the same rock fracturing - or 'fracking' - process can also be used to tap into gas reserves that were once unattainable.

And as a result, there's now a lot of it. In fact, the amount of natural gas stored in the U.S. hit a record 3.85 trillion cubic feet last month, sending natural gas prices down while crude oil prices rose.

The price-dropping gas glut isn't expected to end anytime soon, with some experts saying it may never end. A great part of the reason for weak gas prices is an incredible supply and a weak demand - the U.S. (and the world for that matter) still doesn't have relatively much stuff that actually runs on natural gas, though we can produce natural gas like crazy now. That reality has investors wondering why already-debt-laden Cheniere Energy, Inc. (AMEX:LNG) plans on shelling out another $5 billion on a gas-liquefaction facility it needs to become a net exporter (yes, a net exporter) of natural gas.

The pessimists, however, forget what Cheniere Energy can't ... that consumers all over the world have a penchant for eventually finding a way to excessively use all of what there was once plenty of (corn, bandwidth, gasoline, money, credit, etc.). Translation: Give it some time, and we'll find a way to become natural gas-dependent too. (For more, read Natural Gas Industry: An Investment Guide.)

The Rise of Natural Gas Has Different Impacts on Different Companies
There are four basic categories for companies in the swelling natural gas arena: utilities, explorers/drillers, transportation and the fastest-growing segment - exporting.

While all of them should ultimately benefit from this trend over the long haul, there are unfair pros and cons for each in the meantime, particularly if the supply glut drives prices down.

For the explorers and drillers, persistently weak prices will hurt. It pretty much costs the same to frack for natural gas whether gas is selling at $14.00 per million British thermal units, or $4.00. With the current December 6 price at a very weak $3.63, there's not enough - if any - difference between the selling price and the extraction cost. That's precisely why ExxonMobil has been hesitant to wade into the exploration and export waters - the payoff may not justify it yet.

For utilities, the story is a little different. Cheap natural gas means they can deliver natural gas power or heat much more cost-effectively than they could just a few years ago, yet they still have enough pricing muscle to keep rates disproportionally high. That's been great news for Sempra Energy (NYSE:SRE), which has specifically made a point of moving away from coal-fired power plants and towards natural gas power production.

Any company that can store and export American natural gas is also poised well. But, since there's only one place, anywhere, in the U.S. that can liquefy natural gas in order to transport it by boat, there's also bit of a race to enjoying that upside. Cheniere Energy is likely to win that race, as it intends to build such a facility in Louisiana. It'll be worth the $5 billion as long as foreign demand stays firm, and prices at least move progressively higher over time.

Those pros and cons may switch or fade if-and-when natural gas prices soar, or slump.

The Bottom Line
The beneficiaries of the natural gas boon either way are the companies that own the pipelines; they simply collect a fee for transmitting gas from one point to another, regardless of the price. That puts a company like Enterprise Product Partners LP in a prime spot for growth in the sheer volume of natural gas business. It will take years for all of this to pan out as infrastructure is developed, but it's coming, and true long-term investors need to start digesting it now. (For a tutorial on this industry, read Commodities: Natural Gas.)

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At the time of writing, James Brumley did not own shares in any of the companies mentioned in this article.

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