Is It Worth Investing in Natural Gas?

Most people have heard by now that we're in the midst of a natural gas boom. The U.S. is the world's top producer of natural gas, and this nation's shale deposits have become a playground for gas companies. But today's primary method of extraction, hydraulic fracturing, has sparked a great deal of controversy. As public animosity grows, environmental advocates push for bans on the technique, and federal regulatory bodies launch investigations, investors must stop and ask themselves: Is it worth adding natural gas to my portfolio?

U.S. natural gas stats
Energy Information Administration statistics indicate that there are 862 trillion cubic feet of recoverable natural gas trapped in the shale beneath our feet right now. Dry shale gas production has quadrupled over the last five years, and accounts for almost 25% of total natural gas production, which was estimated at 2.5 tcf in 2010.

Natural gas consumption is increasing slowly, driven by demand from the industrial and power sectors. The EIA estimates the rate of consumption will rise from 67.1 billion cubic feet per day in 2011 to 67.9 billion feet in 2012.

Numbers don't lie, ever. Right, guys?
The New York Times has dedicated a whole section of its "Drilling Down" series to a bundle of documents from industry insiders proclaiming domestic gas reserve estimates are overblown, grossly exaggerated, and bubble-like.

The database contains emails from administrators at the EIA expressing concern that many of these gas companies will go bankrupt chasing dreams of natural gas riches. Naysayers point to expensive leases and uncertainty in production levels over the life of a well as potential dangers.

Looking for answers, the New York state attorney general subpoenaed three natural gas producers this summer to clarify the formulas companies used to predict future production from their wells. New York has $45 million of pension money invested in the three companies subpoenaed, Range Resources (NYSE: RRC  ) , Cabot Oil & Gas (NYSE: COG  ) , and Goodrich Petroleum (NYSE: GDP  ) , as well as Chesapeake Energy (NYSE: CHK  ) , which was also asked to provide similar information.

Bankruptcy? Really?
It may be hard to picture an oil and gas company going bankrupt, but when you consider how much money it takes to drill, and how depressed natural gas prices are in the U.S., the demise of a small outfit suddenly doesn't seem too farfetched.

When Brigham Exploration and Petrohawk Energy were bought out this year, their capital expenditures were running two and three times over cash flow. That's OK in the short term, unless you're operating in a region where the breakeven point for production is $5 or $6/mmbtu and gas sells for less than $4/mmbtu. Compound that with the potential that the wells you're operating aren't in the "sweet spot" of a particular shale play and can't produce as much gas as initially anticipated. Then you might have a problem. Obviously this will not apply to every gas company, but is conceivable for some smaller operations.

Moving on to greener pastures
The price of natural gas is prohibitively low for production in some fields, and companies are starting to do something about it. Take the Barnett Shale in Texas, for example. Many producers there have begun to abandon the methane play in favor of the oil and natural gas liquid-rich properties in other parts of Texas. As of the middle of October, there were only 53 active rigs drilling in the Barnett; the rig count hasn't been that low since 2004. Conversely, there were 395 rigs drilling in the NGL- and oil-rich Permian basin in West Texas and 195 rigs in the Eagle Ford field in the southern part of the state.

Top U.S. producers
The top nine U.S. natural gas producers are a mix of integrated majors that operate on a global scale and domestically inclined independents. Their production numbers vary widely, but I encourage investors to focus on another metric: U.S. natural gas as a percentage of total production.

 

Company

Total Production (MMcfe/day)

U.S. Nat. Gas as % of Total Production

1 ExxonMobil (NYSE: XOM  ) 26,376 14.50%
2 Chesapeake Energy 3,049 84.50%
3 Anadarko (NYSE: APC  ) 4,110 56.60%
4 Devon Energy (NYSE: DVN  ) 3,960 51.20%
5 Encana (NYSE: ECA  ) 3,395 54.90%
6 BP (NYSE: BP  ) 20,598 8.90%
7 ConocoPhillips (NYSE: COP  ) 9,840 16.80%
8 Southwestern Energy (NYSE: SWN  ) 1,364 98.70%
9 Chevron (NYSE: CVX  ) 16,140 8.00%

Source: Company statements.

When Fool Energy Editor Dan Dzombak originally published this list, he pointed to Southwestern Energy as a stock for investors looking to cash in on a pure-play natural gas investment. The company keeps costs low and dedicates essentially all of its production capabilities to U.S. natural gas. That works for investors convinced of the future of the industry in this country, but it's an unmitigated risk for those who are not.

Big risk equals big reward. If the natural gas industry is everything it says it is, then companies like Southwestern and Chesapeake have a high upside. If the industry goes bust on false hopes of high reserves or gets completely hamstrung by regulation, these same companies will sink like stones. Wary investors are better off mitigating the risk with companies like ExxonMobil and Chevron, which have more balanced production numbers.

Global opportunity
Production is booming at home, but success in the industry is beginning to develop on a global scale. The price of natural gas is much higher in Europe, higher still in Asia, and companies like Eni (NYSE: E  ) and Anadarko, with recent discoveries of natural gas off the coast of Mozambique, have put themselves in an excellent position to cash in.

France has banned fracking, and residents in the United Kingdom have blamed a recent earthquake on the process (studies show they may be right). The eurozone has said it won't go as far as banning the process across the bloc, but public opposition is high and is likely to curb drilling activity, which in turn will keep prices high. High prices are essential to U.S. players Cheniere Energy (AMEX: LNG  ) and Dominion Resources (NYSE: D  ) as they continue to develop their liquefied natural gas export programs.

The long and the short of it
It can be easy to make investment choices based on examining income statements and balance sheets. If a company is healthy, buy; if a company is sick, sell. When an entire industry is in flux, things become more complicated. The Fool has often preached writing down your investing thesis for a particular company to remind yourself why you invested if and when things get hairy. That logic more than applies to natural gas; the industry's constant twists and turns require investors to test and retest their theses. What's worth investing in today may not be tomorrow. I encourage Fools to share their thoughts on natural gas investing in the comments section below.

Can't get enough natural gas? Click here to check out the Motley Fool's special free report "One Stock to Own Before Nat Gas Act 2011 Becomes Law."

Fool contributor Aimee Duffy doesn't own shares of the companies mentioned in this article. If you have the energy, check out what she's keeping an eye on by following her on Twitter, where she goes by @TMFDuffy.

The Motley Fool owns shares of Devon Energy. Motley Fool newsletter services have recommended buying shares of Southwestern Energy, Chevron, Dominion Resources, Range Resources, and Chesapeake Energy. 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 (5) | Recommend This Article (24)

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 November 11, 2011, at 2:48 PM, Flash1937 wrote:

    But then aren't the enviros in a box? To discourage fracking which yields a clean burning energy source can only mean more reliance on dirtier fossil fuels. How do they mitigate that situation?

  • Report this Comment On November 11, 2011, at 10:03 PM, Chaffs wrote:

    I'm relatively new to individual stock investing, but two of my first picks were Chesapeake and Dominion, as I'm a huge believer in nat gas (and D has a respectable dividend). I know it's probably making me less diversified than I should be (of six stocks I own, two are energy), so I'd love to get opinions on which one I should get out of, and when an upswing might be in sight (still a few points below my cost basis on each, and if I bail on one, I want to at least break even).

    That said, I see huge potential for the industry here in Pennsylvania. The Marcellus Shale is one of the largest natural gas deposits in the country, and the state and local governments here are more friendly than oppositional. Even if the estimates for the total yield in the country are blown up (say we have HALF that much) that could still be a game-changer in the energy world.

  • Report this Comment On November 12, 2011, at 3:07 AM, WaldotheFool wrote:

    Why was there no mention of Lone Star Gas (LSTG)? Isn't Lone Satr a major player in the natural gas business ?

  • Report this Comment On November 12, 2011, at 12:21 PM, cartgolf1 wrote:

    I am overloaded on Nat. gas stocks, I have been for some time now. We know the gas is cheap. We all know that fracking is a dirty little open secret the industry has. So why don't we find another safer cleaner method of extracting the damn stuff. We launch rockets to Mars and Venus, but your saying gas is unobtainable unless we destroy the ground water and cause earthquakes?? They use fracking because it's the cheapest - fastest method, period. We are our own worst enemy. Give this problem of extracting the gas to NASA - or - to MIT. Cal-Tech would have a new method if we gave them the funding and time to develop something new. Instead we have accountants who's only concern to to spend as little as possible up front -so the dollars can roll in. Then do anything to not pay taxes on the income- and flood the market with as many shares as they can get away with. We should federalize one huge gas field, then make it a test area for Grad students of technology,geology, and other drill-ologists to find a method - once found. It becomes to standard method of drilling.

  • Report this Comment On November 12, 2011, at 2:39 PM, don12string wrote:

    Might add to this list of producers, those companies who provide gas to the users.

    Clean Energy Fuels (CLNE) is building more and more Natural Gas Stations for the growing use in automobiles.

    Westport Innovations (WPRT) builds auto engines that burn Natural Gas.

    These may be long term investments but the trend looks promising.

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