Interested in investing in gas? I can understand why. With the glut of domestic resources and expansion in global demand, now is a great time to invest in the long-term potential of gas. However, there are a lot of different parts of the gas value chain that you can invest in; even the term itself is a little nebulous. What follows is a primer about gas, what the different segments of the business are, and some idea of the size of the market.
While this article won't give you specifics about individual companies, it will arm you with a better understanding of the large and complex gas business. And that knowledge should help you become a better investor.
What is gas?
In the context of this discussion, gas refers to any of the myriad companies involved in fossil fuels in their various forms. This could be upstream oil and natural gas exploration and production, or E&P, companies, midstream companies handling the transportation and storage of oil and gas, downstream companies that refine and process gas and crude into marketable products, and integrated oil and gas companies involved in more than one part of the value chain. It can also refer to utilities that specialize in supplying gas to residential and commercial customers, typically via underground, urban pipelines.
Gas, of course, is a relatively broad term. For the purposes of this article, however, it will refer to the context above.
How big is the gas industry?
Both as a stand-alone industry, and within the context of global energy demand, it's massive.
Think about it this way, as well: Four of the largest integrated oil and gas companies that U.S. investors can easily buy stock in, ExxonMobil, Royal Dutch Shell, British Petroleum, and Chevron, combined for $1.5 trillion in revenue during the past year. And these aren't even the largest companies out there, with Saudi Aramco, and several other massive state-owned oil and gas companies, producing even larger annual revenues.
For the American investor alone, there are literally hundreds of companies to choose from, and domestic production of oil and gas is expected to keep growing for the next 20 years. It's significantly important, and a growing market.
How can you invest in gas?
One of the great things about this broad segment is that it offers a variety of companies with characteristics to meet almost any investor's goals. For example, a growth-oriented investor might closely follow small independent E&P companies, looking for companies with the best reserves to exploit and grow. On the other hand, an investor who's more concerned with capital protection and income can choose midstream companies, which often have very large and consistent cash flows that are paid back to investors in dividends or distributions, often using vehicles like MLPs in order to increase payouts.
When researching companies, it's also important to use proper valuation metrics. Many common metrics don't apply as well to oil and gas companies, whose revenues can often fluctuate wildly based on the wholesale price of oil and gas. Here are a few important metrics to consider:
Upstream E&P companies
Look for growth in proved resources. This is a measure of how much oil and gas the company has rights to produce, and the value of an E&P can decline rapidly if its reserves start to fall. It's also important to understand the costs of production in the area or areas the company operates in. The cost to produce gas can vary widely based on the geography of the region, access to midstream assets like pipelines, and distance from end markets.
For companies like pipeline operators, which often pay out significant dividends or distributions, the payout ratio -- which measures the percentage of net earnings that are paid back to shareholders -- can give some indication of the sustainability of the payouts. It's also important to understand the value of expected cash flows from long-term contracts, as well as the potential CAPEX costs for maintenance of pipelines, and potential expansion.
A great measure is ROCE, or Return on Capital Employed. This is a measure of how effective the company is at taking each dollar of capital it invests into the business, and turning it into more dollars. The higher the percentage of return, the better job management does at maximizing resources profitably.
Use these measures in the context of the long-term trends for the company and the industry, and not in isolation. These aren't the only metrics and measures to know, but they should point you in the right direction. Use this as a starting point to building your own knowledge base. Understanding the industry and sector that the companies you follow participate in is just as important as knowing the company itself -- maybe more important -- because it gives you the proper context to make the best investment decision that you can.
Jason Hall has no position in any stocks mentioned. The Motley Fool recommends Chevron. 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.