Natural Gas: The Perfect Contrarian Investment
Many investors like to believe they are contrarians, investing against the crowd at key (and highly profitable) turning points. Yet in my experience, few actually do.
Here’s a simple test. Did you view the run-up in internet stocks in the nineties as absurd? Did you avoid speculating in real estate during the housing bubble? Did you buy high-quality stocks during the 2008 financial meltdown? Did you pick up gold back when it was under $300 an ounce? How about oil stocks when crude was less than $25 a barrel?
If you answered “yes” to any of these questions, you’re probably already looking at natural gas.
In mid-2008, natural gas traded above $10 per futures contract. Since then, prices have collapsed. Every day, the U.S. natural-gas market is flooded with an average of three billion cubic feet more than the nation consumes. Shares of most companies have taken a drubbing over the past year, even as the broad market has risen.
In sum, the news about natural gas has been almost uniformly awful. And that’s a good thing. As renowned investor Jeremy Grantham recently wrote, “Everyone who has a brain should be thinking of how to make money on this in the longer term.”
The shale gas revolution has cut the price of natural gas about 45% over the last year alone. New discoveries and innovative drilling techniques, along with recent mild weather, have led to a vast oversupply. According to the U.S. Energy Information Administration (EIA), national inventories have risen 56% over the past year.
No Space Left to Store Natural Gas
The market is so awash in natural gas, by this fall there could be no space left to store the stuff in the entire United States unless demand surges or producers seal their wells. We may be creating a surplus that is beyond our capacity to store.
Needless to say, that has put heavy pressure on prices. Historically, natural gas has been 10 times cheaper than crude oil. As I write, it is approximately 35 times cheaper.
Given this scenario, why would anyone in his right mind invest in natural gas right now? Because this discount is not just enormous, it’s unsustainable. Natural gas is preferable to coal and other fossil fuels because it is clean burning, easily transportable, and much more affordable. Over the next few years, the free market will turn natural gas into the answer for our country’s energy problems.
It’s already happening. Electrical utilities and trucking companies, among others, are already switching from coal or diesel to natural gas.
Waste Management says 80% of the trucks it purchases during the next five years will be fueled by natural gas. Navistar (NYSE: NAV), Cummins (NYSE: CMI) and General Motors (NYSE: GM) are all courting the market with new natural-gas powered trucks or engines. Navistar’s goal is to expand to a full range of products using natural gas in the next 18 months. The company says that within two years, one in three Navistar trucks sold will burn natural gas.
And we are only at the tip of the tip of the tip of the iceberg here. Less than one-tenth of 1% of vehicles on U.S. roads burn the fuel today. Clearly, this is going to be a big area of future growth.
Steer Clear of Chesapeake Energy
But what’s the best way to play it?
Not by buying Chesapeake Energy (NYSE: CHK), despite all the ink that’s been spilled. Yes, the company has wonderful gas assets. But it also has a boatload of problems that could sink your investment.
There has been a number of revelations about Chesapeake CEO Aubrey McClendon over the last few weeks and few of them are good. Among other things, Chesapeake saddled itself with about $1.4 billion of previously unreported liabilities through off-balance-sheet finance deals.
Yes, things could get better at Chesapeake, but they could also get a lot worse. It would be a shame to recognize the great opportunity that currently exists in natural gas and buy the wrong stock.
A much better investment, in my view, is a company that controls 1.1 million acres in the Marcellus Shale Play, a particularly attractive target for energy development in the Appalachian Basin. It also has hundreds of thousands of acres in low-cost, low-risk areas in West Texas, New Mexico, Oklahoma, Mississippi and Kansas.
Over the last decade, this firm worked tirelessly to lower its cost structure, strengthen its balance sheet and upgrade its inventory. As a result, the company now finds itself in the best position in its history.
Even with falling natural gas prices, it achieved record operating results in 2011. Proven reserves increased 14%. Production grew by 12%. Yet reserve replacement was 849%. It was the company’s sixth consecutive year of double-digit growth in both production and reserves.
Yet the best is still ahead. Results over the next several years will substantially exceed those of prior years. Liquids production will increase by 40% this year alone. I estimate earnings will jump sharply this year and then triple in 2013. That’s if natural gas prices remain depressed. If they rise, earnings will really skyrocket. And so should the stock.
That’s why this stock is the newest addition to our Oxford Trading Portfolio. And in fairness to existing members, I cannot reveal the company’s name here.
However, I do invite you to join us and become an Oxford Club Member and benefit from our many services, including our award-winning recommendations. To learn more, feel free to click here.