Wind and solar get a lot of press these days, and that's causing investors to miss an even bigger energy megatrend that's right under their feet. That trend is fueled by the fact that natural gas demand in the U.S. is set to explode. Here's how to cash in on the natural gas megatrend.
Natural gas: The future fuel of choice
It was just a few short years ago that coal commanded roughly 50% of the U.S. power generation market. However, today, that share is down to 33%, according to the U.S. Energy Information Administration. What's surprising about this trend is not because Americans have gone green and completely embraced renewables, because wind and solar still supply only about 5% of our power. Instead, the slow demise of coal is entirely due to the growth of natural gas power generation, with gas expected to generate about a third of our electricity this year. Looking ahead, by 2030 coal is only expected to generate 18% of America's power, while natural gas is expected to supply 39%.
That's largely because natural gas is cleaner and cheaper than coal, while also being more flexible and reliable than renewables. In fact, natural gas is increasingly becoming the backup to renewable power generation because it works when the sun doesn't shine and the wind doesn't blow.
That said, the flexibility of natural gas extends far beyond the power sector and beyond the U.S border. It's a critical petrochemical feedstock that's used to make everything from fertilizer to plastic. It's also vitally important to heat homes and businesses. Further, it's starting to make some inroads in replacing diesel in the transportation industry. Finally, demand for American gas isn't just domestic with an increasing amount of gas projected to be sent both south of the border and overseas.
Add it up, and these demand drivers are expected to fuel a 40% increase in natural gas demand over the next decade.
Own the tollbooth
While this demand trend should bode well for top domestic natural gas producers such as Chesapeake Energy (NYSE:CHK), producers are often their own worst enemies. Chesapeake has taken on a mountain of debt to grow its production in anticipation of this megatrend, only to flood the market with gas and further deflate prices. It's continued to burn through through billions of dollars in cash each year, which at current gas prices is putting its long-term financials in question.
On the other hand, natural gas pipeline owner Kinder Morgan (NYSE:KMI) signs up gas producers and consumers under long-term fee-based contracts. It's akin to a tollbooth business model, because it collects recurring fees regardless of the price of gas, providing the company very stable cash flow. At the same time, Kinder Morgan continues to build out its pipeline network and is currently in the process of investing $9.1 billion in new natural gas pipelines, most of which are demand-driven pipelines. These pipelines, along with new projects it develops over the next few years, will fuel a growing supply of cash flow into the company's coffers.
The takeaway is clear: Natural gas is a megatrend that investors are missing. But producers aren't the best way to profit from this trend, because direct exposure to commodity prices could lead to weak returns. Instead, the real winner here is the fee-based business model at Kinder Morgan, because it will benefit from growing demand while staying largely immune to weak prices.
Matt DiLallo owns shares of Kinder Morgan and has the following options: short January 2018 $30 puts on Kinder Morgan and long January 2018 $30 calls on Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. 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.