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The American Energy Information Agency's latest Short-Term Energy Outlook projects falling oil prices and rising natural gas prices over the next two years. This is quite a change from recent times when natural gas prices have suffered while crude oil prices remained strong. With anemic U.S. crude consumption, there are many reasons to start weighting your portfolio toward natural gas.

It is time to bet on natural gas
New U.S. environmental regulations are pushing utilities away from coal and toward natural gas. At the same time, the world's LNG trade is growing at an alarming pace. Together big fundamental changes are pushing natural gas forward.

Crude oil is in a different situation. Refined crude oil products are not going to fall off the face of the earth, but U.S. demand for gasoline is expected to fall slightly from 2013 to 2015. More efficient vehicles and conservative driving habits are putting a lid on America's oil consumption.

One company worth considering
Statoil (NYSE: STO  ) is a great example of a company with interests in the natural gas and oil markets. In Europe it is able to fetch more than $8 per MMBtu for its natural gas -- far above U.S. rates.

In the first three quarters of 2013, its production was pretty evenly split between natural gas and crude oil. Statoil produced 815,000 barrels of oil equivalent per day of natural gas and 1,124 mboepd of crude oil. It is running a very successful upstream exploration program, finding the biggest conventional volumes in the world for the third year in a row. In North America it is active in the Marcellus region and produced 100.9 mboepd of natural gas in the third quarter of 2013.

Another great reason to consider Statoil is its valuation. It trades with a reasonable price-to-earnings ratio of around 12. Its dividend yield of 3.5% should not be overlooked. Based on 20-year rolling time frames between 1940 and 2011, dividends are estimated to provide more than half of the S&P 500 index's total return. Statoil's dividend points to positive shareholder returns in the decades to come.

The in-between play
Chesapeake Energy (NYSE: CHK  ) is heavily invested in natural gas, but it is killing its natural gas production in favor of liquids. In Q3 2013, its crude oil production grew 23% year over year, its NGL production grew 31% year over year, and its natural gas production fell 10% year over year. In the same time-frame it managed to boost liquids production from 21% of total production to 27% of total production. 

Hopefully management will realize that natural gas is a good long-term market. Right now natural gas is not sexy, but its demand is expected to grow consistently over the coming decades. Stronger natural gas prices will help boost Chesapeake's bottom line and pay down its $12.7 billion in long-term debt.

Expensive oil plays
Small exploration and production, or E&P, companies like Kodiak Oil & Gas (NYSE: KOG  ) and Continental Resources (NYSE: CLR  ) offer huge growth at a price. These companies are heavily oriented toward crude oil. 86% of Kodiak's reserves are crude oil. Continental's recent quarterly earnings show that oil production accounted for 88% of its revenue.

The danger is that Kodiak and Continental are putting too much money into oil production. Soft oil prices may eventually force these companies to cut back their capital expenditures, leaving them with big debt loads and unsustainable balance sheets. Kodiak's production grew from 1.3 mboepd in 2010 to an estimated 29.2 mboepd in 2013. Continental grew its annual production from slightly less than 15 mmboe in 2010 to 36.3 mmboe as of Q3 2013. Such massive growth rates are only sustainable for a limited amount of time. A company can only double its production for so many years before it runs out of acreage.

Apart from these issues Kodiak and Continental are expensive. Kodiak is trading around 23 times trailing earnings, and Continental is trading around 27 times trailing earnings. These companies are high-margin companies with high growth rates, but oil prices continue to soften, and demand growth remains low.

Final thoughts
The Energy Information Agency sees softening oil prices and rising natural gas prices over the next couple years. Cheaply priced companies like Statoil with healthy natural gas and crude oil production should be fine. Even Chesapeake may come out a winner, as long as management doesn't kill its natural gas operations. The real danger is that small oil-oriented exploration and production companies like Kodiak and Continental may face falling margins, reduced capex budgets, and reduced growth.

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Read/Post Comments (8) | Recommend This Article (6)

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 January 22, 2014, at 6:33 PM, speculawyer wrote:

    Falling oil prices? LOL. Good luck with that. They can't drop very far because they'll quickly drop below the cost of extraction for the more expensive things like fracking, tar sands processing, ultradeepwater, etc. When they stop drilling those resources, the supply drops and the price shoots back up.

  • Report this Comment On January 23, 2014, at 4:56 AM, amvet wrote:

    (1) In 2012 Statoil led all of the giants in finding new oil and NG. Significant.

    (2) An EIA prediction about price is about worthless. Remember when oil was $10 and they predicted it would remain at $10 for ten years. They want a low oil price to help the US economy. To this end, each month they report a much higher oil production (around 40% higher) in Texas than the Texans say they produce. ?????

    A reminder that the USA is not the world. US oil consumption may be declining slightly but global oil consumption is increasing. In addition production declines in producing oil and NG fields are eating much of the increases coming from new fields in new fields. A lot of great discoveries are short term, e.g., Thunder Horse in the GOM peaked after ten months. The earth awash in oil, a US economist´s dream.

  • Report this Comment On January 23, 2014, at 5:56 AM, krazygranny wrote:

    every time there's an article or news story about falling oil prices the price at the pump jumps 20 cents a gallon

  • Report this Comment On January 23, 2014, at 7:34 AM, PeakOilBill wrote:

    The EIA is a joke. Nobody can predict the price of oil, except to say that, over time, it is going way up.

    I can remember their estimates of oil prices from about 15 years ago. They actually predicted that the price of oil would go up a little, and then begin to fall! How did that work out? WTI is at $97 a barrel. Brent is at $108.

    If Iran and Iraq manage to produce all the oil they can, the price will fall a little for a few years, but as older fields all over the world begin to run dry, and as fewer and fewer new large oil fields are discovered, the oil price will begin to increase rapidly. China imports more oil every year.

    Since there is no substitute for oil, and since it powers 95% of ALL transportation, the economy will probably collapse soon after oil output begins to actually decline. And about 30% of all the energy used by man today, comes from burning fuels made from crude oil. The plan to replace all that work with some other fuel is what?

  • Report this Comment On January 23, 2014, at 8:09 AM, ponchoman49 wrote:

    Remember that 3.50 per gallon is cheap to these idiots so don't expect much if anything less than what it is currently. No instead they are going to start raping us from natural gas and artificially raise the price which will put a further dent in people's wallet. The rich get richer.

  • Report this Comment On January 23, 2014, at 10:44 AM, genefo wrote:

    We the consumer have been waiting for six years. The economy has been waiting for six years. In the meantime the oil giants have been making billions of dollars by price fixing. Don't forget 50% of the American people are poor and they can't afford $3.50 a gallon prices. The economy will do very well if prices fall below $3 a gallon. Why? because studys suggest that for every 10 cents reduction in gas prices releases 40 billion dollars into consumer spending and this my friend gets us out of recessions, and back to a healthy economy.Where are the antitrust watch dogs.

  • Report this Comment On January 23, 2014, at 5:46 PM, rogeroiler wrote:

    is panhandle oil a good investment company

  • Report this Comment On January 24, 2014, at 12:17 AM, foolsgold99 wrote:

    Yeah, there's a substitute for oil and that's ethanol. As long as they keep increasing exports of refined oil there is going to more demand for ethanol. Forget electricity and Tesla the future is ethanol and bio-chemicals.

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Joshua Bondy

Joshua Bondy works in the energy and materials sector. He works hard to bring to light the underlying forces that drive prices and move the market.

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8/28/2015 3:11 PM
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