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Oil prices get the flashy headlines, but natural gas will steal the show. That's what a recent report from the International Energy Agency suggests. Investors still have time to get in and ride this wave.
The IEA believes we could be on the brink of a golden age of gas, where consumption of natural gas would soar by some 50% over the next quarter-century, as China, Germany, the U.S., and other large economies shift their energy use increasingly to gas. So which stocks should you buy to benefit from this shift?
I drink your milkshake, sir
With oil near $100 a barrel and a limited ability to quickly increase supply, economies across the world are looking for cheaper and more plentiful energy sources. Enter natural gas. IEA reports that the world contains enough gas resources to maintain current production for more than 250 years.
New drilling technology called hydraulic fracturing, or fracking, has enabled the extraction of natural gas from shale rock. That technology has allowed natural gas players such as Chesapeake Energy (NYSE: CHK ) to rapidly increase production in places like the Marcellus shale in Pennsylvania and New York and the Haynesville shale in Louisiana and Texas. In fact, the Haynesville has been estimated to be the largest natural gas field in the contiguous United States.
Some of the biggest players are already positioning themselves while prices are still cheap. ExxonMobil (NYSE: XOM ) acquired natural gas player XTO Energy in 2009 for $41 billion. That acquisition moved Exxon into clearer contention with Chesapeake and Southwestern Energy in the unconventional natural gas business. Norway-based Statoil (NYSE: STO ) has also undertaken a deal with Chesapeake to gain exposure to the U.S. gas market. The IEA estimates that the next quarter-century will see "40% of the growth in total gas production will come from unconventional gas," according to The Wall Street Journal.
But gas is also attractive for at least three other reasons.
- While oil reserves are highly concentrated in politically unstable regions, natural gas reserves are more dispersed geographically, making gas more suitable for energy security.
- The recent nuclear event in Japan has raised awareness of the dangers of nuclear energy, prompting some players such as Germany to eliminate nuclear energy and switch to gas.
- China is already putting strains on oil supplies and is expected to drive the proliferation of gas, too. Cleaner-burning gas is expected to replace coal in the nation's power plants.
Despite these favorable long-term trends, there still looks to be short-term pain for natural gas producers.
Everyone is barreling into oil now
Because oil prices are so much higher than gas prices, it's still much more profitable to drill for oil than gas. And energy explorers can use the same technologies to drill for either. All that means you should see a shift in productive resources from gas to oil, as companies seek to maximize their short-term profits.
Even gas giants such as Chesapeake are moving into oil because of the price disparity between oil and gas. For example, Sandridge Energy (NYSE: SD ) snapped up Arena Resources in 2010 for its oil reserves. All else equal, the shift will help push the prices of oil down and gas up. It's estimated that gas prices could rise to at least $6/mcf from their current level of $4.80 and that would still leave plenty of opportunity for explorers to exploit the price differential between gas and oil, if oil remained at current prices.
So even while many energy players scramble for short-term profits on oil, gas looks like an increasingly compelling long-term play. As my Foolish colleague Dan Dzombak explains, you want to be buying commodities such as gas when they're cheap and blood is in the streets. That's what Exxon did a couple years ago with its purchase of XTO, but there's still time to act since oil prices sit at historically high prices relative to gas.
Where to play it
The safest way to play any commodity is to buy the low-cost provider. In the case of natural gas that means Ultra Petroleum (NYSE: UPL ) . Its costs are significantly below those of even Southwestern Energy, whose production price is also below current gas prices.
America's cheap natural gas has also opened the opportunity for export to the rest of the world. Companies such as Cheniere Energy (AMEX: LNG ) and its subsidiary Cheniere Energy Partners (AMEX: CQP ) are hoping to take advantage by opening LNG export facilities on the Gulf of Mexico. The parent recently raised funds via a secondary offering, and the Department of Energy has given the company approval to export LNG to any nonembargoed country. With the approval, the company will expand its LNG operations, although gas won't ship from the expanded location until 2015.
A sticky wicket
Even as it suggested that gas was entering a golden age, the IEA warned that concerns over fracking had the potential to derail the development of gas as an alternative to oil. Critics have contended that fracking contaminates drinking water and fouls natural habitats. And explorers have refused to reveal the ingredients in their fracking solutions, making the public even more wary of the process, cheap energy or not. Given that this concern is gaining wider awareness, unconventional gas plays may not get off the ground.
Fortunately, there's one stock that investors can turn to. Regardless of whether we use gas or oil to meet our energy needs, we'll use the following company. Click here to get the name of that company in our special free report "The One Energy Stock You'll Ever Need."