Natural Gas: The Perfect Contrarian Investment

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club

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.

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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.

Good Investing,

Alexander Green

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The Basic Truth About Natural Gas

From time to time, our experts whether Alexander Green or any other make a recommendation that they’re a bit early on. As we say over and over, nobody can time the market and foresee widespread sell-offs…

For instance, Alex made a call on Rackspace (NYSE: RAX) in early 2011. The stock performed well for most of the year, however the volatility in August brought the stock down and it hit a trailing stop. While trailing stops are usually a great way to protect yourself, there are some times when they backfire. Rackspace went on to blow up in early 2012 after Alex stopped out of the position.

Another one of these situations could be brewing for a recent Insider Alert pick that Alex made – Basic Energy Services (NYSE: BAS). Alex made the call on Basic Energy Services on May 1. And due to the market sell-off in May, Basic Energy fell with the broad market and hit its trailing stop on May 15.

But while the trailing stops protect investors who are already in the stock from incurring unacceptable losses, that doesn’t mean people who don’t already own the stock should steer clear. And the timing looks exceptional right now for Basic Energy…

On Friday the company reported its first quarter earnings and the biggest news from that announcement was that the company is buying back approx. $35.2 million worth of shares. Add that to the recent insider buying and you have a perfect storm of buy signals.

As Alex has written before: “In a recent study…stocks that were the subject of both repurchases and insider buying beat others by a whopping 29 points over four years.”

Here are some of the things Alex likes about the company:

“Based in Midland, Texas, Basic Energy provides essential well site services to oil and gas drilling companies throughout the United States. It’s focused on the most prolific oil- and gas-producing regions in the country and has over 100 service points in 13 states. Basic Energy provides a comprehensive range of well site services that are fundamental to establishing and maintaining the flow of oil and gas throughout the entire life cycle of a well.

“However, the stock hasn’t been a good performer of late. From over $37 a share less than a year ago, Basic Energy has plunged to around $15.

“Some people think this is an overreaction. One of them is Director Steven Webster. He recently bought more than 52,000 shares, an investment of more than $700,000. Another is Director Thomas Moore, Jr. He bought 11,000 shares a few weeks ago too.

“What are they thinking? Perhaps this: buy low, sell high.

“Revenue at Basic Energy jumped more than 50% last quarter. Operating margins top 14%. And management is earning a healthy 26% return on equity.

“I estimate that Basic Energy will earn almost $2.50 a share this year. That means the stock is awfully cheap at just six times prospective earnings.

“Insiders know this. You should follow their lead.”

Alex may have been a tad early, but you could be right on time…

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