What's fueling the boom in natural gas


(A version of this article appeared in optionMONSTER's Open Order newsletter of March 2. )

As stock investors, we dream of secular bull markets. That's when mega-level forces such as technology, social trends, and finance line up just right to drive share prices to unprecedented highs. It's what happened with tech stocks in the 1990s and emerging markets last decade, and now something similar appears to be underway in natural gas.

Before looking at individual names, let's consider some of the elements driving this boom.

Output: More natural gas is being produced than ever before.

After stagnating at 23 trillion to 24 trillion cubic feet (TCF) between 1970 and 2006, U.S. production numbers are pushing into new record levels. Production continued growing throughout the financial crisis and climbed another 3.22 percent to 26.85 TCF from 2009 to 2010. Last year, in fact, every month except January, February, and July set new records.

Advances: Secular bull markets often involve new technology.

Advances in seismic imaging have significantly increased the efficiency of operations, and when they do break the surface they can extract more energy thanks to techniques such as coiled tubing and slimhole drilling. They have also expanded the use of a method known as "fracturing," where water or CO2 is used to break rock so that gas can flow more freely.

This has been key to increasing production to so-called shale properties, which hold vast amounts of gas that was previously unrecoverable. Perhaps even more important have been advances in transportation using liquefied natural gas ( LNG ), which allows the fuel to be shipped on tankers. (See our coverage of Cheniere Energy for more on that trend.)

Customers: Quietly, the U.S. is becoming a major gas exporter.

Everyone talks about how the growth in China and India are driving gains in agriculture. However, while our dependence on Canadian oil has roughly doubled in the last decade, our northern friends have increased their imports of U.S. natural gas tenfold to 732 billion cubic feet during the same period while U.S. imports from Canada have stagnated. Shipments to Mexico have tripled as well.

Something also seems to be happening with Europe. Energy Department data shows that the United Kingdom imported natural gas from the United States for the first time ever in November and then increased volume more than 80 percent the following month. A cursory survey of news articles also indicates that the country is increasing its reliance on LNG.

Domestic use, on the other hand, has barely budged over the last decade. Industrial consumption has fallen steadily, offset by increased electrical generation.

Politics: Mideast unrest has put energy policy back in focus.

It's a bigger problem for Europe than the United States because the continent relies more on oil from North Africa and Arabia. But don't forget about Russia, which has also occasionally threatened to cut off Europe's gas supply. Given our abundance of gas, plus our political stability, we could be in the early stages of a transatlantic export boom.

Then there is green energy. While U.S. vehicular natural gas use is confined mostly to buses, it has enormous potential. It's produced domestically (no money going to regimes that hate us) and will appeal to voters and politicians of all political stripes.

Prices: The potential for rate hikes is the elephant in the room.

Despite the recent gains in oil, natural-gas prices have remained around $4 per thousand cubic feet. At the same time, speculators have grown increasingly bearish, driving short interest to the highest level in more than two years.

"If crude continues bananas to the upside, some of the big hands will look at that and try to run natural [gas]," said Addison Armstrong, director of market research for Tradition Energy. "I think the risk/reward on that trade is probably to the upside."

Companies: Which stocks look good?

Names such as El Paso and Williams have been the leaders so far, rallying more than 50 percent in the last six months. This is an area where everyone needs to find ways to do their own research because understanding natural-resource companies can be extremely difficult.

If you understand geology, or have family in the industry, take advantage of that knowledge. Most of use will need to take our cues from the options action and the charts.

Stocks such as Chesapeake Energy, Range Resources, Noble Energy, and National Fuel Gas have been on the radar so far. Get to know them and look for good entry points. (CHK and RRC, for instance, are worth watching to see if they hold support after recent drops.) Then there is always takeover potential if big oil names want to grow in the sector.

The main message of this article is that we're in the midst of a long-term secular bull market.

The trend is likely far from over. Pullbacks are to be bought.

Disclosure: I am long RRC.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Copyright © 2010 OptionMonster® Holdings, Inc. All Rights Reserved.

This article appears in: Investing , Options

Referenced Stocks: CHK , EP , LNG , RRC , WMB



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