Two hot plays on natural gas

It's been a tough year for gas traders, and gas prices will remain low for some time yet. But you can still make money from natural gas. Here, Eoin Gleeson picks two interesting stocks.

No one has enjoyed the arrival of winter more than gas traders, says Eoin Gleeson. The first snap of cold sent the gas pit of the Mercantile Exchange into a frenzy gas prices have soared from a seven-month low of $2.50 per million British thermal units (MMbtu) to $4.71/MMbtu in just four weeks.

It's at least a month before the really cold winds start to blow in New York and Chicago, but traders are already expecting a glorious surge in demand as Americans flick on the central heating and gas plants come to life.

It's been a tough year for gas traders. The worst economic slump since the 1930s killed off demand for gas. To compound the misery, a cool and rainy summer kept air conditioners in the US off leading to a summer slump in demand for electricity. By September, crude oil closed at a price 37 times higher than gas spot prices. In more normal times, oil trades at six to 12 times more per barrel.

So it's little wonder that gas traders are so primed to drive prices higher. But they've got way ahead of themselves. The huge glut of gas that built up during the energy slump isn't going to be burned off this winter. America has so much natural gas right now that it's choking on it. Every available pipeline, tank, crevice and rock is full of the stuff. The US Department of Energy predicts that stored gas will reach 3,800bn cubic feet by the end of October dangerously close to the estimated peak storage of 3,889 billion cubic feet. And a lot more gas is on its way. New liquefied natural gas (LNG) plants in Qatar, Russia and Indonesia have contributed to a global glut.

America, one of the few countries with large gas storage capacity, will see the bulk of those imports - they have nowhere else to go. Meanwhile, concerns that long-term supplies of gas will run short have also been eased by the opening of the vast shale gas resources in America. These are thought to hold enough gas to supply the country's needs for 100 years, says Ed Crooks in the FT.

So although the gas price is jumping all over the place right now, unless there's a freak hurricane or a genuine economic recovery, prices will remain low for some time. The Energy Information Administration expects spot prices to average $4.31/MMbtu this winter, down from $5.66/MMbtu last winter. Yet many gas producers are already pricing in a sudden surge in gas prices Chesapeake Energy is up 75% in the last three months.

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One unconventional gas play that still looks interesting, however, is coal-bed methane outfit Green Dragon Gas (Aim: GDG). The fire-damp found in coal deposits is an excellent substitute for natural gas. Green Dragon explores, drills and processes the methane in China's coal seams to sell to power plants. Creating electricity from gas is the industry's strongest growth area. It's a lot cheaper to run a gas-fired plant than a coal one. They are cleaner too producing half the carbon dioxide of a coal fired plant. And they are cheaper to build less than $1m per megawatt of capacity, compared to four to five times that for nuclear and wind farms. Over the 35 years since 1973, the proportion of the world's electricity coming from gas-fired plants has risen from 12% to 21%. That's expected to rise to 30% over the next two decades.

Last month, Green Dragon announced it was planning a move from Aim to a main market listing in either London or Hong Kong. Revenue rose to $18.7m in the first six months from $2.4m the previous year. It's still loss making, although the loss narrowed to $11m from $12.3m the year before. But having signed a joint venture with ConocoPhillips in August, it has the resources to develop its huge licence areas in China.

The drive to store gas is a big story in Britain too, especially as we source more gas from Vladimir Putin. Portland Gas (LSE: PTG) is fighting to develop the UK's largest gas storage facility in Dorset potentially providing 5% of peak daily gas demand. The planning process has now been completed. It trades at 123p, up 34% since we tipped it. But it could retest its 430p peak if it secures the £450m financing it needs to finish the Dorset project.

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