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Energy lies at the heart of every aspect of our modern world. It's incredibly cheap in the U.S.; most people spend more money on entertainment than electricity or gasoline every month. The fact that it's so cheap, and so prevalent, while also being dominated by big names like ExxonMobil, often leads investors to skip right over the sector when looking for the best investments. Skipping past the one sector -- energy -- where there is going to be guaranteed growth in demand over the next several decades, could be foolish (small f).
Smaller, more specialized companies like Ultra Petroleum (NYSE: UPL ) and Chesapeake Energy (NYSE: CHK ) , and manufacturers like steelmaker Nucor (NYSE: NUE ) are great plays on how domestic natural gas is driving the U.S. economy upwards. Let's take a look at how the domestic boom in natural gas production is helping to lift the U.S. economy, and three ways patient investors with a long view can be rewarded.
Direct growth in production
After a double-whammy of historically low gas prices and mismanagement by founder and former CEO Aubrey McClendon, the new leadership team at Chesapeake, led by CEO Doug Lawler, has done a commendable job of deleveraging the company and focusing on the most profitable production assets. This has led to a strong return to profitability, with net income (adjusted, non-GAAP) up more than quadruple the year-ago period in the third quarter, after reporting adjusted net income growth of more than 800% in the second quarter.
Actual production of natural gas has declined due to the sell-off of assets, but when the year-ago period is adjusted to account for these sold assets, production at the retained assets is up around 8%. With this refocusing, oil has become a stronger driver for Chesapeake. The nation's second largest gas producer saw oil production grow 23% last quarter, and management is projecting oil production to be up as much as 34% for the full year.
Ultra Petroleum has been more of a pure play on natural gas, with only about 3% of its production volume in the third quarter in the form of crude oil. So far in 2013, 12.6% of revenues are from oil, versus 18% from 2012. However, the company's acquisition of properties located the Uinta Basin in Utah, will add a large volume of oil to the company's mix.
How large is the impact? Ultra had produced 865,000 barrels of condensate through the third quarter of the year. The new acquisition currently produces 4,000 barrels per day, or 1.4 million barrels per year. With these new assets added to the mix for all of 2014, the company will more than double its 2013 oil production, at a cost of less than $75 per barrel, according to management. With oil trading at more than $110 per barrel today, there should be plenty of income generated from this new play, even with the added $450 million in debt the company just announced in order to pay for this asset.
While Chesapeake is reemerging as a low-cost producer and fiscally conservative exploration company, Ultra Petroleum has been one of the best-run domestic producers, consistently keeping its costs below $3 per Mcf (only $2.80 per Mcfe in Q3) for most of the past several years. This cost advantage means that, with the exception of the historically low natural gas prices seen in 2012, Ultra is able to be consistently profitable.
Secret weapon for domestic manufacturing
Nucor Steel has been stuck in the downside of the industrial cycle for the past several years, as demand for metals dried up during the global recession. However, the cycle is beginning to turn, and in no small part due to the domestic energy boom. Nucor is taking advantage of this in two ways.
The company's partnership with Encana to produce natural gas will give the company a competitive advantage over peers, in both its cost structure, as well as the products it can produce. Not only will the company reduce its direct energy costs, but it will be able to generate additional revenue from gas produced beyond its needs, which it will sell on the open market.
The direct-reduced-iron, or DRI, that will be made in the Louisiana facility that will be fired with natural gas, is located near the geographic heart of much of the natural gas world, especially pipelines that are tied to both domestic distribution and many of the 20 natural gas liquefaction facilities that are being built in the country over the next decade to facilitate massive exports of natural gas to lucrative overseas markets. Since the oil and gas industry is steel-intensive, locating facilities in areas where it can more quickly and cheaply service these customers is another potential advantage over Nucor's competitors.
Global demand is creating a domestic economic tailwind
Production of oil and natural gas is just the beginning of the story, and Nucor is only one of many companies being lifted by the domestic growth in energy production. The long-term story is how this domestic asset, which is more valuable in foreign markets, will drive exports of natural gas and petrochemical products, as well as other domestic products that can be produced as cheaply here, as in foreign markets, due to the reduced cost of domestic oil and gas as both a feedstock and as an energy source.
Add these three factors together, and it points to a continuation of growth in demand for domestic natural gas and oil. It also indicates further lifting of the U.S. economy and oil and gas-intensive industries. For patient investors, this is a great opportunity to build long-term wealth.
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