Profit from the American energy revolution

published 13 April 2012

Natural gas is dirt cheap in America at least.

The US price of natural gas has just reached its lowest point in a decade. It's now below $2 per million British thermal units (Btus).

That's great news for any American who uses natural gas to heat their homes. Indeed, it's helped to offset some of the pain US consumers have felt from rising petrol costs.

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And in the long run, it's fantastic news in general for the US. Who wouldn't want a massive supply of cheap energy right on their doorstep?

However, it's a real nightmare for the companies who get the stuff out of the ground. The share price of many natural gas producers has taken a hammering alongside the gas price.

But could now be a good time to buy?

The price of natural gas has collapsed

The price of natural gas is now so low that oil and gas companies in the US are converting their drilling rigs and vehicle fleets to run on it.

As Reuters reports, Canada's Encana Corp "already has 15 of its more-than 40 rigs driven by gas". Apparently, two years of fuel savings can cover the cost of converting from diesel to gas.

The chief executive of US oil and gas group Apache Corp, Steve Farris, recently argued: "What we need to do is increase the amount of natural gas demand in this country. From an economic standpoint, it's a no-brainer."

You can see why he's desperate to boost demand. As you'll probably know by now, new technology (hydraulic fracturing, or fracking') has freed up a huge amount of natural gas from once-hard-to-reach places in the US.

That's been tough on gas producers. Supply has run well ahead of demand, and prices have toppled as a result.

However, this state of affairs will be temporary. You can't create a source of reliable energy at a time when the oil price is over $100 a barrel, and expect it to remain cheap forever. We'll look at what could turn things around in a moment.

But even with gas prices this cheap, there are ways for smart investors to profit.

Cashing in on the natural gas glut

One option is to get exposure to the US dollar in general. As James Ferguson pointed out in a recent issue of MoneyWeek magazine, the natural gas glut' is just one reason to expect the US dollar to strengthen sharply in the coming months and even years .

If the US has to import less energy, then that'll be good for trade figures, and thus for the dollar. On top of that, sitting on top of a cheap source of energy bodes well for manufacturing in the country. Again, that could close the US trade gap.

We've mentioned ways to get exposure to the US in the past, both through US-listed companies and those in the UK that are heavily reliant on dollar revenues. Stock markets look like they'll be wobbly for a few months, so you might get better opportunities to buy.

But one option to consider if you don't already have it is pharma giant GlaxoSmithKline (LSE: GSK). It's defensive, gets a lot of its revenues in dollars, and is in a popular sector right now healthcare (which is the subject of the cover story in the current issue of MoneyWeek). For disclosure purposes, I will point out that I own shares in Glaxo in my personal portfolio.

Could the natural gas price be set to turn around?

What about natural gas producers themselves? I certainly think it's worth taking a look at them. The fact is, natural gas prices can't keep falling. Pinpointing the turnaround is impossible of course, but a lot of factors are coming together that could contribute to higher prices.

Environmental concerns about the impact of fracking' could stymie production. And it's also possible that the producers have over-estimated the amount they can get from the fields.

But far more important than either of these issues is the fact that low prices are their own cure. With natural gas at these levels, there's every incentive for the US to find ways to use more. There's also plenty of incentive for producers to leave the gas in the ground where possible.

For example, US financial newspaper Barron's likes the look of the afore-mentioned Encana (NYSE: ECA). Its share price has almost halved in the past 12 months, falling along with natural gas prices.

However, the company is now cutting its spending on dry' natural gas and looking to expand production of oil and natural gas liquids'. These liquids which are normally produced alongside the gas trade at about half the price of crude oil. So it's a lot more profitable than the gas itself.

Encana has also been smart enough to hedge its exposure to falling prices. As Dimitra Defotis notes in Barron's, more than half of the company's 2012 production is hedged near $5.75 per Btu, well above the sub-$2 level natural gas is at just now. With the cost of production set to fall to $3 per Btu in the coming years, the company could do very well from even a modest recovery in gas prices.

The company also pays a decent-sized dividend yield of around 4.4%. And as Defotis points out, it has a 30% stake in a liquefied natural gas (LNG) export facility on Canada's west coast. This isn't in operation yet, but when it is, it will be a starting point for shipping LNG to Asia, where gas prices are much higher than in the US.

It sounds an attractive play to us. Sure, gas prices might fall further, and it will be dragged down along with them. But at some point prices will recover, and Encana should still be around to take advantage when they do.

Meanwhile, in the next issue of MoneyWeek, my colleague Phil Oakley will be taking a close look at one of the biggest US natural gas producers Chesapeake Energy and telling us whether it's time to buy or not. If you're not already a subscriber, you can subscribe to MoneyWeek magazine.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.