Hydraulic fracking may be controversial, but there is little doubt it has brightened the prospects for some U.S. energy companies. Fracking, along with a handful of other less politically charged technologies, has improved the ability to extract and distribute U.S. natural gas so dramatically that it has sparked something of a gold rush mentality among investors.
Perhaps with good reason. As recently as 2006, natural gas production fell to record lows, but has spiked upwards since, so that in 2012 the U.S. set a new record with shale-gas responsible for 39 percent of the total, according to Mike Ciccarelli, equity analyst at Briefing.com. By 2035, shale-gas contribution will make up half of total production, according to the Energy Information Administration, an arm of the Department of Energy. Around 2016, the agency predicts, the U.S. will become a net exporter of natural gas.
Abundant supplies mean lower prices. Natural gas values are holding around $3.70 per million British thermal units (Btus), a fraction of near $14 per million Btus hit in June 2008, and slightly off last year’s multi-year lows of around $1.87.
Compare the current low domestic prices to LNG prices in $10 to $11 per million Btus paid in Europe and the $14 to $17 per million Btus in Asia, and it’s easy to see why the export market is exciting. “That’s a huge arbitrage and represents a tremendous opportunity,” said Anton Bayer, chief executive officer of Up Capital Management.
Of course with natural gas, there is a bottleneck. Pipelines are inefficient to move gas around the world. So companies are liquefying the natural gas to more easily export it.
The DOE approved its fourth LNG export terminal to Dominion Cove (ticker: D) in September. The three other approved projects belong to Cheniere (LNG), Sempra (SRE) and a project to be run jointly by BG Group and Energy Trading Partners (ETP). Cheniere was the first approved and is slated to begin exporting LNG in 2015.
Darren Schuringa, managing partner at Yorkville Capital, said the four terminals would account for 10% of the demand for natural-gas output, based on current production levels.
The DOE increased the approvals rate recently and some industry watchers think this means the DOE will quicken the pace further. There are 19 outstanding projects in the queue.
Yet not everyone is happy with the push to export energy, specifically manufacturers who are benefitting from cheap natural gas. They’re afraid more exports will inflate domestic prices, which is leading to some Congressional debates, Schuringa said. This could slow the process.
Quint Tatro, president of Tatro Capital, rejects the concerns about higher prices. He said given the massive supplies, the EIA forecasts that natural gas spot prices by 2050 might only rise to $7.83, using 2011 dollars.
Schuringa said even if the DOE doesn’t approve all the new terminals, the longer-term outlook for exports is still solid, given the global LNG market.
“The play on exports is still good if LNG price spreads remains wide. It can be profitable for a great, long time. There’s no reason why prices should become much cheaper when you consider supply and demand on a global basis. It’s a depleting resource, like all fossil fuels,” he said.
What Else To Know
Even though natural-gas usage is growing, crude oil will likely always have some influence on natural gas, Bayer said. The two energy sources are linked by the exploration process and many global LNG prices have been traditionally indexed to crude oil, he said. That’s partially why global LNG prices are so high and why the U.S. as a natural gas producer can take advantage of the differences in margin, he adds.
“If crude oil prices were to rise, it could bring up natural gas prices. But there’s just not enough demand now. In North Dakota you see a lot of flames at night; they’re burning off the natural gas because there’s not enough demand,” Bayer said.
Tatro said as long as natural-gas production continues apace “this is really a promising sector.” His main worry is if there is some major natural disaster related to production which could essentially halt the entire industry. Specifically, he is concerned about the potential for earthquakes related to fracking.
“The concern for the environment is huge. All we need is a massive earthquake to disrupt this. We saw what happened in Japan and the nuclear power,” he said, referring to the Fukushima disaster.
Fracking opponents also cite the issue, but the U.S. Geological Service said that “the actual hydraulic fracturing process is only very rarely the direct cause of felt earthquakes.”
The natural-gas sector is not for the conservative investor. Much rests on the DOE’s commitment to approving exports, demand for liquefied natural gas (LNG) market and the continued ability to recover the fossil fuel.
There are no exchange-traded funds that focus on the LNG space, so investors have two options: buying shares in publically traded companies or through master limited partnerships, known as MLPs. The MLPs are popular with investors because of high yields, but can be complicated because of their special tax circumstances.
Cheniere is considered the purest play of the four terminal operators. Mayer said he owns the stock, while Schuringa said he owns the MLP, Cheniere Energy Partners (CQP).
All the money managers said interested investors should also look at two tanker companies, Teekay (TNK) and Golar (GLNG). Tankers are like pipelines in the sense that they deal with volume of goods moved, so they’re protected from swings in commodity prices, Schuringa said.
It’s important to note that many of the companies in this space are trading at or near 52-week highs, but these gains aren’t surprising, Ciccarelli said.
“In general, given the state of the LNG market and these companies, the general trend should continue to be upwards for now…. It’s just critical to watch what the Department of Energy is up to in regard to the LNG space. Any negative talk from them would probably make me sell my exposure to the space and patiently reevaluate,” he said.