Should you add natural gas to your portfolio?

Gas burners on stoves with a graph of growth in natural gas prices — (Image credit: Getty Images)

I want to look at what I can only describe as a stealth bull market: natural gas. The price is creeping up, and few are talking about it. Natural gas is a bit like silver: if it can disappoint, it will. So we begin this piece with that reminder. Natural gas has broken the soul of many a wiser man than me.

On the other hand, the next five years look pretty positive. It’s obvious that the world is going to go nuclear now, and that small modular reactors (SMRs) are going to provide the power artificial intelligence so badly needs.

However, it will be a good five years before they come on stream, so what is going to provide the power in the interim? The answer is natural gas. There is a problem though: supply. America’s gas wells seem to be drying up.

MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Obviously, we in the UK and Europe pay way more for our natural gas than they do in North America. It’s absurd: we have enough to supply ourselves in the UK. But we don’t because fracking is deemed environmentally damaging.

So we import gas from abroad, which is produced by, you guessed it, fracking. I suppose if it is fracked somewhere else, it’s less harmful. Then there are the transport costs and the environmental costs that come with that.

Where does the US get their natural gas?

Spanning Ohio, New York, West Virginia and Pennsylvania, Marcellus is the largest natural gas-producing field in the United States, contributing over 25% of production. In 2010, output was two billion cubic feet per day (bcf/d). By 2023, it exceeded 35 bcf/d, but production has been falling for almost a year now. We are currently at 26.7 bcf/d.

The next largest is Haynesville, in Louisiana, Texas, and parts of Arkansas. Extraction costs here are higher, and production stands at 16 bcf/d, but it is slowing here too, according to analysts Goehring & Rozencwajg. One of the few areas of growth is the Permian Basin, in Texas and New Mexico, currently producing approximately 23 bcf/d, but even there, growth is modest.

Now, it may be that the reason for stagnating growth is low prices, and higher prices will result in increased production. They usually do. That is the way with commodities. But natural gas prices have already doubled to around $3.50 per MMBtu this year, and they keep on creeping up. The other interpretation is that the North American shale gas revolution has passed its peak.

With America’s new president, you can expect plenty more investment in production than under the Democrats, and that should bring the price down, but the gas price rocketed after the election (from $2.70MMBtu to $3.50MMBtu) before pulling back to $3.10MMBtu, where it sits now. It may also be that Russian gas taps come back online to the EU next year, which means America will lose its new market.

Beware of calling peaks in natural gas. The world – when regulators allow it – has a habit of finding this abundant and clean energy source, and that always sends the price down. But all of this conjecture is factored into the price. And that is rising. For now.

How to invest in natural gas

The simplest way is to own the iShares Oil & Gas Exploration & Production ETF (LSE: SPOG), which is finally on the move. If you want something a bit more spicy, there is the Diversified Energy Company (LSE: DEC), which is the largest owner of old natural gas wells in the United States.

Diversified Energy acquires existing long-life, low-decline producing wells and then tries to improve or restore production. It hit a rough patch with some “well leaks and accounting tricks”, as my friend Charlie Morris of ByteTree puts it, which got the company into trouble and resulted in a 70% decline in the share price.

But now those problems are behind it, it should face fewer permitting obstacles under the new US administration. It is cheap for what it is: the market value is around $830 million. High-cost producers can be good plays on rising commodity prices. As the price of the underlying commodity rises, they suddenly become profitable.

Company X produces a commodity at £100/ unit. Company Y produces it at £200/unit. The commodity’s price jumps from £210 to £220. Company X’s profits do not even rise 10%. Company Y’s double. On the other hand, if the commodity falls to £190, company Y is in deep trouble.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.