The recent natural gas market crash brought frackers like Chesapeake Energy (CHK +0.00%) to their knees, but now the story is starting to turn around. Bus fleets are leaving traditional diesel or gasoline fuels in favor of natural gas and in some cases saving up to 40% on their fuel bills. The rise of natural gas as a transportation fuel is very disruptive for the energy industry. Not all companies will benefit equally, and some may even see their bottom lines fall.
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Historical overview
The U.S. fracking boom brought massive supplies of natural gas into the market, overwhelmed pipeline capacity and sent prices crashing. We simply do not know what to do with all of the natural gas flowing out of newly developed fields. Every month, Bakken drillers alone are burning off more than $100 million of natural gas because there is no economical way to bring it to market. With the price of crude oil heading north, it is not hard to see why finding new uses for natural gas is a huge opportunity.
The winners
Clean Energy Fuels (CLNE +3.13%) is building a network of new fueling stations to bring natural gas to market. While master limited partnerships are building out new pipelines to bring more gas to market, Clean Energy Fuels is taking the fuel to new commercial customers.
A full 30% of new transit vehicles are powered by natural gas. The real market potential comes from the trucking industry, with 25 billion gallons of annual fuel use. The trucking industry is in a cost war with cheaper methods of transportation like rail, making potential fuel savings from natural gas a life saver.
Clean Energy Fuels is not making money yet, but this is understandable as it is a company in a nascent industry with big capital expenditures. Natural gas vehicles will not be adopted if there is no infrastructure to fuel them, and this company is taking steps to solve the problem.
Overall, the business continues to grow. In the last four quarters, its operating income before depreciation and amortization has improved from a loss of $10.21 million to a loss of $8.5 million. The quick ratio and current ratio are warning signs of a dangerous cash position, at 2.1 and 2.7 respectively. The company does not have an excessive debt load, but it is important to keep your eye on these numbers.
Right now, Chesapeake is focused on developing oil- and liquids-rich plays to save its bottom line. Chesapeake's high debt load has made the company think about short-term profits above all else. Even though management is focused on other issues, in the long run, Chesapeake is one of the companies that will benefit from the growing adoption of natural gas powered vehicles.
A full 40% of the firm's realized revenue comes from natural gas. While its liquids production is a growing portion of its production, the company still expects to produce between 1.08 bcf to 1.10 tcf of natural gas in 2013. Natural gas prices have come back up, and Chesapeake is on track for a profitable year.
The loser
Refiners like Phillips 66 (PSX 1.99%) are some of the biggest losers within this story. Increased demand for natural gas means less demand for refined crude oil products. Also, natural gas is used as an input in many refining processes. Stronger natural gas demand will put pressure on supplies and push prices upward.
In 2013, Phillips 66 estimates that a $0.10 rise in natural gas prices would decrease its worldwide refinery net income by $10 million. Even after accounting for midstream benefits from increased prices, its total net income would decrease by $8 million.
The company has been able to pump out a $19.45 per barrel realized margin on West Texas Intermediate oil in its most recent quarter and an overall return on investments, of 16.7%. These numbers mean that Phillips 66 does not have to start worrying about natural gas vehicles right away, but over the next decade these vehicles could put real margin pressure on the entire refining industry.
Conclusion
Increased demand for natural gas may be enough to make more of Chesapeake's wells profitable. Predicting the future is far from easy, but what is good for Clean Energy Fuels is good for Chesapeake. If natural gas prices stay low relative to diesel, buying these two companies will be a great growth play. Phillips 66 is stuck on the other side of this trend, and it is important for downstream investors to watch the adoption rates of natural gas engines.
