The chart below from the Energy Information Administration shows current projections for U.S. energy production. Notice that crude oil production is slated to peak by around 2020 and then slowly decline. In contrast, natural gas is expected to keep climbing through 2040.
Furthermore, prices for natural gas are projected to climb from their current low levels:
Major player in Marcellus
One of the companies sitting on the some of the most prolific natural gas wells in the Marcellus shale is Cabot Oil & Gas (NYSE:COG). Cabot claims to have 17 of the top 20 producing natural gas wells in the Marcellus play. This has contributed to some of the lowest production costs in the country. Cabot claims its total costs for natural gas production were $3.03 per thousand cubic feet equivalent, or Mcfe, in 2013, an 18% improvement over 2012.
For comparison, Range Resources, which is also active in the Marcellus, has production costs of approximately $3.60 per Mcfe.
These prolific wells did wonders for Cabot in 2013. Total production was 55% higher than 2012, cash flow was 57% higher, and net income 112 % higher. This production was without the benefit of acquisitions. Topping all this off was a 42% increase in proved natural gas reserves.
With all this good news, why did the stock get whacked? First, the stock was set up for a correction after climbing 50% over the past year. Production guidance was for a 25% to 40% increase in 2014 -- not quite as strong as 2013's increase. Furthermore, Cabot is having problems getting a decent price on its natural gas despite the high demand caused by a cold winter. A lack of takeaway capacity (e.g. pipelines) is contributing to this pricing problem.
Put another way, Cabot is producing too much gas for its own good and is seeing lower prices as a result.
What about natural gas pipelines, then?
Cabot's takeaway problems will likely resolve over time, in part because Williams Companies (NYSE:WMB) signed a deal to build a new pipeline to Cabot's Marcellus assets. Williams operates two stretches of pipelines in the United States and a third pipeline in Canada. The interstate pipelines are operated by Williams Partners (NYSE:WPZ), a master limited partnership majority owned by Williams Companies. These pipelines handle natural gas and natural gas liquids.
Williams plans on spending about $26 billion in the next five years to expand its operations in the United States, Canada, and offshore Gulf Coast. Most of the capital will be spent on the U.S. Atlantic and Gulf coasts. Three pipeline projects are slated for completion this year with others to follow through 2018. These projects are supported by 15-year contracts.
All of this bodes well for investors. Not that they have done badly in the past -- Williams Companies has steadily risen for five years, while Williams Partners had a rapid gain back in 2009-2012 but has slowly declined ever since. Williams Companies' dividend grew from a quarterly $0.11 per share in 2009 to $0.4025 in the most recent quarter. Williams Partners' distribution grew from $0.635 to $0.8925 in that same period. Williams Companies currently yields 3.9%, Williams Partners, 7.2%.
A little oil, a lot of gas
Another company producing natural gas is Vanguard Natural Resources (NASDAQ:VNR). This company acquires mature, proven natural gas and oil assets that require a minimum of capital. In this way, Vanguard seeks to maximize output and distributions with the least amount of capital expenditures. While many similar companies eschew natural gas plays, Vanguard embraces them. In fact, natural gas represented roughly 65% of all production in 2013.
Vanguard's acquisitions since 2007 reflect this production bias. Twenty deals were sealed and roughly 66% of these assets were natural gas. As a result, Vanguard's proved reserves grew from 67 billion cubic feet of gas to 1.8 trillion cubic feet. Amazing what spending $3.4 billion can do for your company. 2013 saw two deals finalized that were mostly liquids plays and one deal so far in 2014, which is mostly gas. For the record, Vanguard reported a near doubling of production of all commodities in 2013 compared to 2012.
One recent acquisition involved assets in Wyoming: the Jonas Fields and Pinedale, specifically. In some ways, these plays fit with Vanguard's strategy of acquiring natural gas fields; the properties in question are roughly 80% natural gas, 16% natural gas liquids, and 4% oil.
What is different in this deal is Vanguard will spend money on exploration activities, something it usually avoids. Admittedly, it's a low-risk venture (another Vanguard trait), and the company will work with two operators in the field to improve the odds of steady growth. Time will tell if this exploration venture pans out.
Final Foolish thoughts
Of all these companies, I like the two Williams companies the best. Midstream operations strike me as the safest bet in the energy business. If you need income now, buy Williams Partners. If you can wait and take advantage of dividend reinvesting and dividend growth, Williams Companies offers a compelling investment.
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Robert Zimmerman owns shares of Vanguard Natural Resources. The Motley Fool has no position in any of the stocks mentioned. 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.