Natural gas production companies can't seem to catch a break. Despite more successful drilling and production numbers in 2012, lack of demand sank spot prices to 12-year lows. Now, just as these companies have started to slow down production enough to let demand catch up, Mother Nature has given another big hurdle to conquer: a mild winter.
Unlike oil, natural gas consumption is almost exclusively used on a seasonal basis. Residential, commercial, and industrial use of natural gas comprises 66% of all natural gas delivered to customers, and each of these sectors' consumption mostly comes in the winter months. So it should be no surprise that in 2012, which according to The New York Times was the hottest year since 1895, we saw a 4.7% decline in gas consumption for these three sectors during peak season.
To a certain degree, natural gas is still considered a regional product. We have yet to build out a strong enough natural gas infrastructure such that natural gas can freely move around the globe. Because of this, these abnormally warm winters translate to oversupply of natural gas and thus lower gas prices. In the spring of 2012, natural gas spot prices sank below $2.00 per million BTUs, an almost unprecedented low when adjusted for inflation.
As recently as a couple of months ago, there were signs that natural gas prices would recover. If temperatures remain as high as they have been, though, it could send natural gas supplies surging up again and resulting in another lousy spring for natural gas prices.
No one would be surprised to hear that exploration and production companies who have a strong focus on natural gas will suffer greatly because of this. This is not a new story, because the exact same thing happened in 2012. This is why so many gas-centric companies like Chesapeake (NYSE:CHK) and Linn (NASDAQ:LNCO) have gone to great efforts to shift their operations toward a more liquids centric strategy. If 2012 was a pop quiz for companies to examine the sustainability of their drilling strategy, then 2013 could prove to be the final exam.
But there have to be winners when prices are low, right? You bet. To find a company that can reap the rewards of cheap natural gas, look no further than gas consumers. There are some speculative plays that can build momentum for increased use of natural gas for transportation (here's looking at you, Westport Innovations). More importantly, though, there are companies that can increase their profits now, like utilities. The combination of cheap natural gas and stricter EPA regulations, several utility companies like Duke Energy and Southern have shifted much of their generators to run on natural gas.
Natural gas can also be used in ways beyond energy. It plays an important role as a chemical feedstock for nitrogen-based fertilizers, and companies that produce these products are reaping big rewards on cheap gas. In last quarter's earnings release, CF Industries (NYSE:CF) reported a 25% reduction in natural gas costs which helped them beat analyst expectations despite a fall in revenue. The same can be said for chemical companies. With propylene stocks approaching all-time lows, both Dow Chemical and Enterprise Products Partners (NYSE:EPD) are in the process of expanding their ethylene cracking capacity in the U.S. so they too can profit from natural gas oversupply.
What a Fool believes
Call it what you want, but temperatures across the globe have been higher than normal in the past few years. If this trend continues, then the need for natural gas heating will slowly continue to drop. With the U.S. sitting on a large supply of the stuff, we want to take advantage of it, but we simply don't have the infrastructure in place to utilize it. The market will correct itself, but it still may take a couple of years before demand completely catches up. In the time being, companies like the ones listed above could have a nice run of prosperity while their supply costs remain low.
Tyler Crowe owns shares of Westport Innovations. You can follow him on Fool.com under TMFDirtyBird, Google +, or Twitter @TylerCroweFool.
The Motley Fool recommends Enterprise Products Partners L.P., Southern Company, and Westport Innovations. The Motley Fool owns shares of CF Industries Holdings and Westport Innovations and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. 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.