While coal's fortunes have been waning, the future of natural gas appears to have no limit. Natural gas will continue to impact coal demand, but how long can gas remain cheap?
New drilling techniques have opened up vast domestic oil and natural gas reserves that simply weren't economical before. And, in the near term, there have been notable dislocations because the now plentiful supply overwhelmed domestic infrastructure and demand.
For example, oil flowing into the Cushing, Oklahoma refining region because of new drilling methods started overwhelming the storage and transportation systems there as far back as the turn of the decade. This resulted in a historically wide spread between West Texas Intermediate (WTI) and Brent crude. For many decades, WTI had traded at a slight premium.
Operators in the region, however, have been adjusting to the new oil inflows. One of the most notable shifts was the reversal of the Seaway pipeline by owners Enterprise Products Partners (NYSE:EPD) and Canada's Enbridge (NYSE:ENB). Since pipelines make money from moving oil, usually regardless of that oil's price, helping to ease the supply glut was an opportunistic play only possible because of the new drilling methods.
In early 2012, the project was completed and WTI oil started heading from Cushing to the Gulf Coast. The duo has since begun work on expanding the project, hoping to increase throughput from its original 150,000 barrels per day, or bpd, to as much as 850,000 bpd. And the pipeline ties into storage facilities operated by Enterprise, providing an extra boost to that partnership's business. Although this is just one pipeline within the very large and diverse portfolios of this pair, it should provide years of solid cash flows thanks largely to new drilling methods.
The interesting thing, however, is that oil is a global market. As new infrastructure like the Seaway pipeline has come on line, the spread between WTI and Brent has quickly narrowed. The differential started the year at about $18 a barrel, but by July had closed to just $3 a barrel. The price of WTI, though, rose to meet Brent, not the other way around. So WTI got more expensive.
Less global, for now
That's an important fact to keep in mind. While oil is a global commodity, the domestic natural gas industry, for the most part, is not. For example, BP highlighted in its annual energy review that up until about 2008, U.S. natural gas prices were in line with those from around the world.
At the end of 2012, however, U.S. gas was trading at massive discounts to foreign gas because the supply glut brought about by new drilling methods overwhelmed demand in the largely insulated market. Prices in the United Kingdom were closest at over three times U.S. prices.
Although companies like ExxonMobil (NYSE:XOM) and Shell (NYSE:RDS-B) made ill timed acquisitions of U.S. natural gas assets, they could wind up being big winners in the end if domestic natural gas prices follow the trend that WTI oil set. For now, however, the price of domestic natural gas remains relatively low, though up notably from its 2012 lows.
The big change will be increased domestic demand from utilities and others coupled with, perhaps more importantly, increased export capacity. Competing with foreign gas directly will shift the pricing dynamic of natural gas the world over. Like WTI and Brent, prices will likely converge higher than where domestic natural gas is trading hands today. Even if that shift is just a few dollars, the percentage increase from recent gas prices in the mid-$3 range would be huge.
With the financial strength to hang on through the low prices, both Exxon and Shell are worth watching since their natural gas assets are viewed as negatives today. When the market turns, that negative will quickly turn into a benefit to investors. And you can benefit from the relatively high yields the two offer while you wait.
The "big" shift
And the export shift is gaining steam, as new export facilities get built and approved. For example, Cheniere Energy Partners (NYSEMKT:CQP) IPOed in early 2007 to own liquefied natural gas receiving facilities. The idea was that foreign natural gas would be delivered to the United States. The new drilling methods changed that and turned Cheniere's business model on its head. But it also left Cheniere with a valuable asset—a terminal "headed the wrong way."
Like Enterprise and Enbridge, Cheniere is working on "shifting direction," turning toward an export model. That will position the partnership to be among the first to send U.S. natural gas to countries without free-trade agreements. The export facility has been approved but isn't up and running just yet. That said, Cheniere already has customers from around the world lined up. When the partnership finally starts shipping LNG overseas, its prospects will quickly brighten and so, too, will the prospects for domestic natural gas prices.
Cheniere is a direct play on LNG exports, but it isn't the only company looking at the space. There are over a dozen other companies either with permits for LNG export facilities or trying to get applications approved. This isn't a blip, it's a ground swell.
Natural gas looks to have a bright future, but the low prices that exist today aren't going to last forever. That will materially change the dynamics of many industries, including those that also make use of coal—like electric utilities.
Companies like Exxon, Shell, and Cheniere are all looking to benefit from the same type of price discrepancy that took place on the oil side at Cushing. If gas prices head higher, like WTI oil did, this trio will be in prime position to benefit. But so, too, will many coal companies since higher gas prices will make coal even more price competitive than it is today.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Enterprise Products Partners L.P.. 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.