Has natural gas hit a bottom. If so, how to invest?

Posted By on February 15, 2012

Besides trading in an out of the depressed Natural Gas market in the past month, I’ve been pondering how to “eventually” capitalize on what I see as a bottom in the commodity price for NG and a possible upside down the road. How far down the road, who knows?

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I’ve been doing some reading regarding different ways to profit on future demand. First, the new “fracking” drilling method now makes it possible to extract more gas from the same wells. This increases the amount of natural gas and decreasing the cost … so that will need to be calculated into the producer picture. There are companies strategically positioned to capitalized in hydraulic fracking – I’ve added a small position in Heckmann Corp (HEK).

Another piece of advice that I’ve picked up is to stick with companies that make money from moving natural gas … pipelines. One of the pluses to investing in companies like Spectra Energy, El Paso Pipeline Partners and Williams Partners LP; Williams owns nearly 14,000 miles of pipelines and charge a fee for every cubic foot of natural gas they move through their pipes. Supplies don’t matter as these companies make money whether NG is cheap or expensive … and at a time when the U.S. is moving towards clean natural gas as an alternative to coal for electric power plants and as diesel replacement in trucking, they should do do well. Another option rather than individual companies is to invest in an exchange traded note like JPMorgan Alerian MLP Index (AMJ). AMJ yields 4.83% but charges 85 cents for every $100 invested … so beware of the costs associated with buying ETNs.

I’m not comfortable investing in the drillers and those companies that are drilling new wells yet, as these companies are dealing with such low NG prices that there is little incentive to keep their rigs drilling. They are also battling the environmentalist who have targeted the process of injecting water and chemicals in the underground cracks and have suggested that this method is contaminating drinking water and creating earthquakes.

Another option is to look for companies that benefit from the lower natural gas prices. These are companies that use NG in their products such as chemical, plastic and fertilizer companies. A couple of the big boys are Dow Chemical (DOW) and DuPont (DD) (which I mentioned in December 2011).

Dow Chemical Co, for instance, depends on natural gas to manufacture plastics used in everything from toys to artificial turf to diapers. The company is expanding its capacity in the United States to produce ethylene, a key plastics component that is derived from natural gas.

Dow Chemical may be something of a momentum play. It is up 14.6 percent so far in January, and trades at a P/E of 13.5. It yields 3 percent.

Companies like DuPont, meanwhile, will likely see costs for producing fertilizer, plastics and other products decrease, said Doyle from Morris Capital Advisers. Natural gas is a component of ammonia, which is used in fertilizer production.

That will likely help them both at home and overseas. Demand for fertilizer alone, part of the $700 billion chemical industry, is expected to grow by 3 percent worldwide in 2012, according to the International Fertilizer Industry. The chemical industry is one of the top U.S. exporters, according to Zacks Investment Research.

DuPont is up 14 percent this month. It trades at a P/E of 13.4 and yields 3.3 percent.

LINK

Natural Gas ETFs:

Natural gas price tracking exchange traded funds is another way to make money if there is a rise in the price for natural gas. The downside is that if gas continues to head south (possible but the move has been significant already) or that it will trade in the current range for years to come. I’m of the school that natural gas is near a low and although I’ve never been accurate at “picking a bottom,” I do think that the downside risk is lower than the upside.

* LINK to article warning about UNG

UNG is forced to continuously sell the front month and buy the forward month. This is a problem because of the contango in the natural gas market. Below are the prices for Henry Hub Natural Gas futures over the next year.

  • Jan 2012- $ 3.12
  • Feb 2012- $ 3.17
  • Mar 2012- $ 3.20
  • Aprl 2012- $ 3.26
  • May 2012- $ 3.31
  • Jun 2012- $ 3.35
  • Jul 2012- $ 3.41
  • Aug 2012- $ 3.44
  • Sep 2012- $ 3.45
  • Oct 2012- $ 3.47
  • Nov 2012- $ 3.88
  • Dec 2012- $ 4.03

As you can see, prices for natural gas are higher in each month that is "further out" on the futures curve. This means that UNG loses the difference between each month. So, if natural gas prices remain flat and end December 2012 at 4.03 UNG will lose the enormous 89cent spread between Jan and Dec natural gas.

The natural gas stocks are a much better way to play natural gas itself than UNG. Companies that hold natural gas underground will receive higher prices going forward. These stocks include Chesapeake Energy (CHK), Southwestern Energy (SWN), Anadarco (APC), Sandridge (SD), and other smaller natural gas companies. Major integrated oil companies such as Exxon Mobil (XOM), and Conoco Phillips (COP) also have major natural gas holdings. These should benefit from any upside in natural gas. The (FCG) is another way to play it, this ETF owns a group of natural gas stocks. Investors looking for more risk could consider Cheniere (LNG), Cheniere is hoping to export natural gas from America to foreign nations where gas prices are much higher.

Conclusion: Investors who believe in natural gas should be buying the natural gas companies, not UNG.

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