When to Invest in Companies Hurt by Low Natural Gas Prices

Sir Issac Newton's gravitational theory is summed up in one sentence: What goes up, must come down. When it comes to economic theory, though, we also assume that if the price on a limited commodity goes down, then it must go up at some point. In the case of natural gas prices, companies on both the winning and losing sides of the shale gas boom are anxious to know when the party (or plight) will change. Lets take a quick look at where natural gas prices are, where they are going, and how it should affect your portfolio decision making.

Companies from both sides of the aisle
The shale gas boom of the past 18 months or so has sent reverberations throughout the U.S. energy markets. Without sufficient demand for this product, spot prices went on a steady decline all the way down to 12-year lows back in April of last year. This has has a profound effect on several companies, and not always in a good way. There are three major industries that have been hit the hardest by low natural gas prices: natural gas producers (think Chesapeake Energy  (NYSE: CHK  ) ), coal producers (Peabody Energy), and utility companies that don't have many natural gas operations (Excelon (NYSE: EXC  ) ).

Henry Hub Natural Gas Spot Price Chart

Henry Hub Natural Gas Spot Price data by YCharts.

On the other hand, both chemical companies and manufacturers have had a pretty impressive run thanks to cheap feedstocks. Companies like LyondellBasell and Terra Nitrogen, which both use natural gas as a feedstock for plastics and nitrogen fertilizers, respectively, have seen impressive margins in these past couple of quarters thanks in large part to these low gas prices.  

Henry Hub Natural Gas Spot Price Chart

Henry Hub Natural Gas Spot Price data by YCharts.

Which firms' activities could lead to price increases? 
So how long can we expect natural gas prices to stay down? Surely the prices for a limited resource cannot stay low for long. For this to happen, we will need to see a major uptick in domestic consumption, export volumes, or a combination of both. There is some momentum for both of these directions. Cheniere Energy (NYSEMKT: LNG  ) has locked in long-term contracts to export 2 billion cubic feet per day of natural gas to foreign markets, and both Clean Energy Fuels (NASDAQ: CLNE  ) and Westport Innovations (NASDAQ: WPRT  ) are spearheading the movement to make natural gas a viable transportation fuel in the U.S. If and when these ideas start to take hold, expect natural gas prices to grow right along with these companies.

Based on current prices for natural gas futures contracts, this may take longer than some expect.

 

Source: Barchart.com, authors calculations (futures prices as of Feb 11, 2013 @ 13:00).

The problem with relying on exports and new demand as a catalyst for higher gas prices is the time associated with these ideas. Cheniere does not expect to make its first delivery of exported natural gas until 2015, and it will surely take even longer for any company to build out an infrastructure to make natural gas a comparable replacement to gasoline as a transportation fuel. So, unless there are any major shifts in domestic production in the next couple of months, don't expect prices for natural gas to change too dramatically.

What a Fool believes
The natural gas party will not last forever. As long as there is a disparity in energy prices, either between domestic and foreign markets or between comparable energy sources, there are companies out there that will look to take advantage of the situation, which will ultimately bring prices to an equilibrium. This means investors could potentially jump into companies that are down on their luck because of low natural gas prices and then ride them for the long term.

While the theory behind investing in the natural gas losers makes sense, keep this in mind: The timeline for these improvements could be longer than many expect. For many of these companies, it makes more sense to try to shift their business strategies for the time being rather than hold out for higher gas prices. Chesapeake energy has done so by shifting its production more toward liquids and oil rather than gas only, and Peabody Energy has gone to great lengths to secure long-term export contracts so it can send its coal overseas.  Moves like these, ones that show a company's ability to shift its strategy when new market conditions present themselves, will lead to much better outcomes than waiting for natural gas prices to rise.

For more on Chesapeake's transformation
Energy investors would be hard-pressed to find another company trading at a deeper discount than Chesapeake Energy. Its share price depreciated after negative news surfaced concerning the company's management and spiraling debt picture. While these issues still persist, giant steps have been taken to help mitigate the problems. To learn more about Chesapeake and its enormous potential, you're invited to check out The Motley Fool's brand-new premium report on the company. Simply click here now to access your copy, and as an added bonus, you'll receive a full year of key updates and expert guidance as news continues to develop.


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Comments from our Foolish Readers

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  • Report this Comment On February 13, 2013, at 3:41 PM, jim1199 wrote:

    The Fool should reread, or read for the first time Hyman Minsky. Natural gas prices are in a deflationary spiral where the end is not in sight. What banker in their right mind would lend CHK any money especially when their saddled with so much debt that they can't repay and the value of their assets are falling by the day? The cost of their financing is also rising. Part of their strategy is to sell assets, so who is going to buy them? A problem for natural gas producers is that when you tap a well you can't just turn it off. So you just have to keep pumping and take whatever price you can get. Natural gas really isn't a commodity and the supposed "market" doesn't really exist. It's a contrived deregulation fiasco pandering to free marketers wishful thinking.

    The only natural gas supplier that I see weathering the storm is ExxonMobile because their deep pockets.

    Natural gas production requires hugh invetments in pipeline infrastructure and with falling prices the financing just won't be there.

    But it will also be a once in a lifetime opportunity when prices turn if you're able to stomach the ride.

  • Report this Comment On February 14, 2013, at 7:13 PM, buffalonate wrote:

    There are several things that will push gas prices up over the next few years. CNG and LNG use for transportation is only going to keep increasing. Many coal power plants are being replaced by natural gas plants over the next few years. Many chemical companies are planning on building new plants to take advantage of the cheap natural gas. Exporting LNG is also going to push prices up. It is impossible for natural gas prices to stay lower than $3 for long because it becomes unprofitable and they will stop drilling for it.

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