Is Natural Gas Fuel Dead Before it Gets Off the Ground?

Just a few years ago, natural gas fuel seemed to be the answer for all of the United States' energy problems. It's in abundant supply domestically, prices are low, and the changeover from using gasoline to natural gas won't require a wholesale shift in the way consumers buy and consume energy.

But the natural gas fuel revolution seems to have lost momentum, and leaders Clean Energy Fuels (NASDAQ: CLNE  ) and Westport Innovations (NASDAQ: WPRT  ) have been market laggards in a year when companies with growth potential have been hot. What has happened? Is the natural gas fuel revolution dead or has the market just missed its growth story?

CLNE Chart

CLNE data by YCharts.

There's no single answer, but investors may be reconsidering the size of the market for natural gas fuels. Natural gas is developing into a great alternative for a niche in the market, not an alternative for you and I in our daily commute, as some had hoped.

Natural gas's momentum is gone
The appeal of natural gas fuel is easy enough to understand. According to Clean Energy Fuels, it can cost $1.50 per gallon less than diesel and results in 23% fewer emissions in the medium and heavy-duty markets they're targeting. Westport Innovations is making the transition easy, designing natural gas engines and equipment to convert consumer vehicles to natural gas. 

But natural gas's cost advantage can easily evaporate, mitigating the need to switch fuels at all. That's exactly what has happened over the past three years, killing some of the industry's momentum.

Henry Hub Natural Gas Spot Price Chart

Henry Hub Natural Gas Spot Price data by YCharts.

Rising natural gas prices aren't the end of the world for natural gas fuel, but they hurt. Between one-third and one-half of Clean Energy Fuels' fuel costs come from buying natural gas. As the price rises, it either squeezes margins for Clean Energy Fuels or makes the switch to natural gas less cost effective for customers, both bad trends for the industry.

Clean Energy Fuels is building hundreds of stations like this one to expand CNG and LNG availability. Source: Clean Energy Fuels.

If there was reason to think that the price of natural gas will fall to $2 per thousand cubic feet again soon I would say there's hope, but when prices were that low drilling for natural gas came to a halt. I don't see the price of natural gas falling much; there's also potential that oil will drop, hurting natural gas's cost advantage.

The U.S. is becoming energy independent
One of the great advantages natural gas once had is that it's abundant domestically relative to oil, which was imported from places like the Middle East. But U.S. shale drilling has changed that picture: net imports of oil have fallen from 60.3% of consumption in 2005 to just 28.5% last year. At the rate production is increasing, the U.S. could be energy independent by 2020.

That creates a tougher political environment for natural gas, which has been helped immensely by tax credits. In fact, last year $45.4 million of Clean Energy Fuels' revenue, or 12.8%, came from the volumetric excise tax credit.

If moving from oil use to natural gas doesn't cut energy imports and requires taxpayer subsidies to be successful, I don't see why a wholesale energy shift would happen. It would make more sense to put taxpayer money into truly clean energies that are already becoming competitive with oil.

Alternative energy competition is growing
Natural gas has a great sales pitch to the medium and heavy-duty trucking market, but shifting those markets isn't the ultimate goal of the natural gas industry. The aim was to capture significant share in the passenger market as well.

The problem today is that electric vehicles are becoming consumers' alternative fuel of choice, limiting the overall market. Tesla Motors (NASDAQ: TSLA  ) has proved that electric vehicles are desirable for consumers, and competitors are also stepping up their game in this space. It helps that there are now more than 20,000 public charging stations in the U.S., dwarfing the slightly more than 1,000 natural gas stations. 

To make matters worse, regional fleets operated by the likes of UPS and FedEx are testing using electric vehicles and fuel cells to power trucks. These regional fleets account for most natural gas fuel sold in the U.S. right now, and if an electric or hydrogen drivetrain can compete it would further hurt the natural gas story. 

The natural gas cost advantage also evaporates when compared to EVs for consumers, plus Tesla has proven that electric performance is far better than a natural gas vehicle. The expansion of natural gas simply took too long while electric vehicles solved many of the engineering challenges limiting their success. Today I see little upside in the consumer market for natural gas because alternative fuel vehicles will trend toward electric.

Infrastructure doesn't exist for a wholesale shift
The final challenge natural gas faces is infrastructure. It costs about $1 million to build a compressed natural gas fueling station; as of the last Energy Information Administration report there were only 447 public stations. That has expanded in the two years since the report, but CNG is in need of massive infrastructure.

Compressed natural gas fuel stations in the U.S. as of March 27, 2012. Source: EIA.

Clean Energy Fuels and Westport Innovations have focused on the medium and heavy-duty markets, which is where America's natural gas highway has promise. But as I pointed out above, that emphasis limits the potential market for these companies and lowers return on investment in stations and engine technology.

Can natural gas fuel come back?
Natural gas could definitely be a big winner in the trucking market. Given the new products Westport Innovations is launching this year and the expansion of Clean Energy Fuels' network of stations, the alternative is very viable. Westport Innovations recently said natural gas had penetrated 1.7% of the 215,039 Class 8 trucks in the U.S. by the end of fourth-quarter 2013 and is rapidly increasing shipments. But this came during the same year the company reported a $185.4 million loss, showing that uptake isn't happening fast enough to make money.

The challenge for these companies is that the changeover to natural gas is expensive, while the fuel's cost advantages aren't necessarily long lasting. Trucking fleets may switch over gradually, but the market will be somewhat limited. Natural gas will also have trouble catching on in markets like consumer vehicles because alternatives provide better performance and more infrastructure.

Investors need to adjust their growth expectations lower and understand the headwinds these companies face. Natural gas is an interesting alternative fuel option but it isn't the no-brainer investment some thought a year or two ago. That makes these stocks high risk, particularly as alternatives improve.

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Read/Post Comments (14) | Recommend This Article (8)

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 April 08, 2014, at 2:00 PM, Honestguy wrote:

    Whay can't some FOOL make up his or her mind abt WPRT and the gas industry. We don't need anymore of these well if maybe stories.

  • Report this Comment On April 08, 2014, at 2:09 PM, okulawd wrote:

    What does Tesla have to do with Westport? Dumpest article I've ever read!

  • Report this Comment On April 08, 2014, at 2:57 PM, tchams wrote:

    Hello Honestguy,

    Buy WPRT.

    Sincerely,

    FOOL

  • Report this Comment On April 08, 2014, at 3:15 PM, Falcon208 wrote:

    What happened to the in-depth analyses and periodic updates on specific stocks MF used to have? They were very helpful -- and would be particularly welcome for a stock like WPRT. This stock was touted heavily by MF in the not too distant past, is still a 5 star stock with much support from CAPS all stars -- yet it continues to drop like a rock. An in-depth analysis and 'where we are now' report from MF is sorely needed.

  • Report this Comment On April 08, 2014, at 3:38 PM, smacunalum wrote:

    Well, a lot of gas drillers simply stopped and wells stopped operations several years ago when the price was too low ...remember? When inventories go down and the price rises, wells will return to operation and a new equilibrium will be found.

    That said, we'll see what happens when the exporting starts.

  • Report this Comment On April 08, 2014, at 7:30 PM, steveks1 wrote:

    This is a good article...no slant either way.

    A better explanation of how NG commodity price changes don't directly equate to NG fuel price changes. That's an enormously important aspect to the cost benefits of NG as a transportation fuel. It really does make the adoption of NG transportation fuel a "no brainer" for long haul trucks, even though the author doesn't agree with that idea.

  • Report this Comment On April 09, 2014, at 9:58 AM, FoolishNature wrote:

    There is a terrific interview with Clean Energy's CEO at http://newsletters.fool.com/18/coverage/updates/2014/04/04/f...

    Its pretty long, but a lot more insight into the industry, prices, growth prospects, partnerships, etc. than Travis here provides. Video and transcript. Check it out.

  • Report this Comment On April 09, 2014, at 11:13 AM, steveks1 wrote:

    Foolish Nature

    I checked out your reference..........nothing but an advertisement for a Motley Fool subscription

  • Report this Comment On April 09, 2014, at 11:21 AM, TMFVelvetHammer wrote:

    Travis,

    I think you're missing some important data points on the shift to natural gas, especially for heavy trucking and in how natural gas prices correlate to the retail cost of natural gas at the pump.

    You should take a look at the interview I did with Andrew Littlefair that was published in Stock Advisor last weekend, for better insight.

    For those of you who don't subscribe to Stock Advisor, the interview will be published on Fool.com in the next several days.

  • Report this Comment On April 09, 2014, at 4:46 PM, steveks1 wrote:

    Travis,

    Additionally, in response to your comment pooh-poohing the idea of NG transportation fuel being a "no brainer" for long distance truckers........Look at it this way: A typical Class 8 truck on a cross country run gets 6 mpg. In simplest terms, a very typical 600 mile day's run will consume 100 gallons of fuel. Natural gas at $1.20 - $1.50 less per gallon, equates to $120 to $150 in the driver's pocket as additional profit.

    I call that a "NO-brasiner" in anyone's book.

    Steve K. S.

  • Report this Comment On April 11, 2014, at 10:45 AM, Rkolodziej wrote:

    Yikes! There is so much wrong with this article that it's hard to know where to start.

    First, economics. The author says: “But natural gas's cost advantage can easily evaporate, mitigating the need to switch fuels at all. That's exactly what has happened over the past three years, killing some of the industry's momentum.” Huh? After one of America’s coldest winters, the NYMEX field price for natural gas is $4.54. At that price, natural gas is the equivalent of 58 cents per gasoline gallon equivalent or 65 cents per diesel gallon equivalent – in the field. There then is the cost of bringing that gas to the pump (e.g., processing, transmission, compression, taxes), which is about $1.25. That still gives natural gas about a $2.00 advantage over a gallon of diesel or gasoline. A big Class 8 truck may use 20,000 gallons of fuel per year. That’s a $40,000 savings – PER YEAR. Natural gas vehicles cost more to buy, but, for many fleets, that higher vehicle purchase cost can be recovered in less than two years.

    Second, US oil production. The author rightly point out that US oil production is growing rapidly – reducing imports, and maybe eliminating them by 2020. What’s that have to do with the price? Where the oil is produced is a separate question from the price of the oil. Are the authors assuming that the oil price will drop in the US to, say, $80 per barrel because it’s produced here? The fact is that the oil price is set by the world price. Despite the increase in domestic production, the NYMEX price for crude today is $103.60 per barrel. The price gap between natural gas at the pump and gasoline and diesel is (and will continue to be) significant.

    Third, government support. The author says that the political environment in Washington for incentives for natural gas vehicles (as with everything else) is getting tougher. That is correct. But that doesn’t mean that Congress won’t extend the incentives that expired at the end of 2012. In fact, the Senate Finance Committee just passed an extenders bill that includes the infrastructure and fuel tax credits that had expired. But the real action is at the state level where a many states have already put in place incentives for natural gas and many others have legislation introduced to do so, too. Unlike some other alternatives to gasoline and diesel, natural gas for vehicles doesn’t require government incentive to be competitive. But the market will grow faster with government support.

    Fourth, other alternatives. The author point to electric vehicles as a growing threat to natural gas vehicles. The demand for EVs will certainly continue to grow, but, unless there is a major (an order of magnitude) breakthrough in battery range, cost and weight, EVs biggest market will continue to be commuter vehicles and light trucks with limited range requirements. Because the natural gas vehicle value proposition is based on “the more you drive, the faster your payback,” the natural gas vehicle industry will continue to focus on high fuel-use fleets and consumers – where EVs don’t compete. There are about eight million big trucks on America’s roads. About a quarter of all on-road fuel used is diesel – mostly in big trucks. That represents a 6 trillion cubic feet potential. Unless technology rapidly changes, 18-wheelers are not going to be powered with electricity – at least not far. Further, the author ignores altogether the huge potential of the market for natural gas in the non-road market (e.g., mining equipment, rail, marine market). This “heavy horsepower” market for natural gas is only in its infancy, but promises to be a huge for liquefied natural gas.

    Fifth, fueling infrastructure. The authors are correct that this is impeding the growth of natural gas in transportation. That’s why the industry had initially focused on “return-to-home” vehicles, where one station in a private depot could serve an entire fleet or one station in an industrial park could serve many smaller fleets. But the industry is now expanding beyond that. Natural gas fueling stations are now being added at a rate of 25 fueling stations per month, and more cities are developing an adequate fueling infrastructure to attract not just return to home vehicles, but smaller fleets and individuals. Meanwhile, Clean Energy, Shell, Trillium and others are building a network of natural gas stations (some liquefied; some compressed) at truck stops around the country.

    The author titled this article: “Is Natural Gas Fuel Dead Before it Gets Off the Ground?” The answer is … no. Just the opposite.

  • Report this Comment On April 11, 2014, at 11:52 AM, steveks1 wrote:

    Rko,

    Your critique of the article seems somewhat harsh. However, I also believe Travis has missed the enormous price advantage natural gas has over diesel for the foreseeable future. Also,your point that 18 wheelers won't be battery powered is certainly correct unless some "Star Trek" fantasy technology becomes reality.

    Natural gas as transportation fuel is happening worldwide, it's just happening a little bit slower here in the USA. Entrenched interests of oil producers and refiners want to perpetuate the status quo, America is far and above the greatest market for refined petroleum products.

    Travis cautiously and sensibly doesn't count on government to help in breaking the "stranglehold" big oil has on America's transportation fuel marketplace. As paraphrased by radio talk show financial guru....."WE HAVE THE BEST GOVERNMENT MONEY CAN BUY."

    SKS

  • Report this Comment On April 11, 2014, at 12:14 PM, steveks1 wrote:

    As paraphrased by radio talk show financial guru, BOB BRINKER....."We have the best government money can buy."

  • Report this Comment On April 12, 2014, at 7:56 PM, kschof13 wrote:

    Excellent rebuttal Rkolodziej. I agree with all of your points but your first point is the clincher as you correctly point out that even at a price that has more than doubled, natural gas STILL provides a significant cost advantage to large fuel users.

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