The Next Huge Commodity Play

Cheap commodities are always out of favor. With natural gas currently trading at $4.30/mcf, the stuff doesn't exactly look like the next gold mine. But how long will natural gas remain cheap -- especially when demand for this particular commodity is predicted to grow exponentially?

My Foolish colleague Dan Dzombak clearly explains why it's important to invest in a commodity when it's fallen out of favor with the market as a whole. That kind of contrarian spirit isn't easy to cultivate. But as Dan explains, that's how fortunes are made.

Why natural gas?
Demand for natural gas in the U.S. will see a sharp increase in the next two decades. According to the Energy International Outlook, consumption in the U.S. is poised to increase by 14% from 2009 to 2035, while domestic supply is projected to increase by 29% in the same period. In short, net imports will be drastically reduced looking into the future as natural gas reserves in the U.S. become more accessible, thanks to more efficient advanced technology.

Industrial and electricity demand
Speaking of demand, the EIA estimates that industrial energy demand will grow into the future at an average rate of 1.2% annually. In fact, demand for natural gas stands at 37.6% of total industrial energy demand.

The industrial sector is undergoing consolidation through mergers and acquisitions, a trend that is expected to continue into the future. In such a scenario, cost-cutting measures and increased efficiency become really important. Efficient natural-gas-powered applications will likely replace those legacy systems that consume a lot of energy.

Additionally, restrictions on industrial emissions are expected to turn stricter, which can only increase industrial demand for clean fuels like natural gas.

Increased electricity generation should heighten demand by an average 1.8% per year through 2025, according to the EIA. Out of 335 gigawatts of new electric generation capacity expected in this period, 57% will be natural gas combined-cycle or combustion turbine generation.

Add to that the replacement of less efficient and environmentally polluting electric generation plants with natural-gas-fired units, and the demand for gas is bound to soar. I believe natural gas companies are well-positioned to profit from this opportunity, especially those currently managing to eke out profits despite an ugly market for the commodity. 

Names to remember
Transportation and pipeline companies will definitely cash in on this development. Boardwalk Pipeline (NYSE: BWP  ) has an extensive distribution network and storage facilities, which includes interstate and intrastate pipelines. The company's three interstate natural gas pipeline systems have approximately 14,200 miles of pipeline and underground storage fields, with aggregate working gas capacity of approximately 167 billion cubic feet.

Canada-based Enbridge (NYSE: ENB  ) distributes natural gas to industrial customers and has interests in transmission and gathering pipelines in the Gulf of Mexico. Compatriot TransCanada (NYSE: TRP  ) has a pipeline network of more than 35,000 miles tapping into various gas supply basins in North America. Watch the transmission industry carefully.

A question of economics
With many companies' cost of production higher than the price at which natural gas trades, it is obvious that producers would want to move to other resources giving better returns such as oil. Hence, with more such companies moving to greener pastures (read oil), it is imperative that demand for natural gas will outstrip supply to the extent that prices will shoot up -- and there is ample room for that. But this is where things look promising.

Here, Ultra Petroleum (NYSE: UPL  ) and GMX Resources (Nasdaq: GMXR  ) fit the bill. Their production costs stand at $2.61/mcfe and $3.59/mcfe, respectively, given that natural gas is currently trading at $4.30/mcf.

Gas utility Atmos Energy (NYSE: ATO  ) has a slightly higher distribution cost at $5.28, but is a good prospect once prices go up. Of course, one can never discount heavyweights such as Chesapeake Energy (NYSE: CHK  ) , even though its production cost for gas exceeds its share price at the moment.

Foolish bottom line
In the long run, Foolish investors have a lot to gain from natural gas. The signs are definitely looking good, and there is no reason why natural gas shouldn't enjoy the status oil has now. Looking for more ideas? Check out The Motley Fool's free report "The Only Energy Stock You'll Ever Need." Just click here to grab a copy.

Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. The Motley Fool owns shares of Ultra Petroleum. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy and TransCanada. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (28)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 24, 2011, at 3:26 PM, DonGrayPeyto wrote:

    I agree that Nat gas will continue to grow in demand. It is an abundant, cheap, clean fuel, that is a big part of a strong, celaner, future North American economy. I would also add Peyto Exploration & Development Corp. to your list of Natural Gas producers that are worth owning. For the record, I'm one of the founders of Peyto. Our company boasts one of NA lowest cost structures, I believe even lower than the Ultra and GMX. We also have one of the longest inventories of proven producing reserves that are currently on production. Even at today's relatively low price, Peyto has been able to profitably develop it's natural gas reserves and has delivered over 30% growth in production per share over the past year. If you want to invest in this part of the energy sector, I would highly recommend you visit Peyto's website at www.peyto.com to see what makes Peyto such a compelling investment in today's natural gas sector.

    Don T. Gray

    Chairman of the Board

    Peyto Exploration & Development Corp.

  • Report this Comment On May 24, 2011, at 6:44 PM, waditude wrote:

    "...consumption in the U.S. is poised to increase by 14% from 2009 to 2035, while domestic supply is projected to increase by 29% in the same period."

    When I studied economics, supply increasing faster than consumption meant lower, not higher prices.

    John

  • Report this Comment On May 24, 2011, at 10:11 PM, skypilot2005 wrote:

    May 24, 2011, at 3:26 PM, DonGrayPeyto wrote:

    "If you want to invest in this part of the energy sector, I would highly recommend you visit Peyto's website at www.peyto.com to see what makes Peyto such a compelling investment in today's natural gas sector."

    Mr. Gray,

    Thank You, for posting.

  • Report this Comment On May 26, 2011, at 1:29 AM, isacsimon wrote:

    @Don

    Thanks for the comments. Will definitely take a look into Peyto. Natural gas definitely looks to have a great future as a clean alternative in North America.

    - Isac Simon

  • Report this Comment On May 26, 2011, at 1:43 AM, isacsimon wrote:

    @John

    I never meant to say total supply will outstrip total demand in future. I wrote "domestic" supply will eventually offset foreign imports. However, total consumption is on the rise to the point that demand will eventually outstrip supply due to companies currently moving away from natural gas production (as mentioned in the article).

    -Isac

  • Report this Comment On May 26, 2011, at 11:31 AM, susan400 wrote:

    Where do these TMF themes come from? Its like someone woke up with an idea anmd they write it up. Are we going to use more and more N-Gas? Yes, Why? We have too much, 100 yrs worth it is estimated. Does that make it a good investment? Maybe not.

    SHALE gas is exploding in output and some can be produced at 2$ and under.

    When NGAS is 1.5 buy some NG stks.

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