• Natural gas inventory is up.
• Rather mild weather has kept demand low.
• Liquefied Natural Gas (LNG) imports are at record highs.

But that doesn’t mean we won’t see a rise in price. In fact, many of us here at Penny Sleuth expect nothing less than a record year for natural gas.

With oil hitting new all time highs every day — it currently sits at $108 per barrel — natural gas will be called on, more and more. You see, oil and natural gas have a unique connection. Many large-scale customers (industrial consumers, electricity generators, etc.) can switch between oil and natural gas, depending on price and supply. We expect many of these customers to make that switch to gas this year.

A second argument for high natural gas prices is the demand for fuel. Whatever your opinions about ethanol are, there’s no question that it’s going to be a big factor over the next few years. The U.S. Congress dictates it. At the end of 2007, Congress mandated an increase in ethanol production of over 414% (from seven million gallons to 36 million gallons) by 2022. But what was forgot in the process was that it takes a boatload of natural gas to produce ethanol.

Here in the U.S., corn is the largest source of ethanol. To grow corn, it takes a lot of fertilizer. The price of fertilizer is 90% dependent on the price of natural gas. Therefore, it takes a lot of gas to make fertilizer. Don’t laugh… On top of that, what do you think these ethanol plants burn to turn corn into their precious ethanol? More natural gas!

But putting the fuel argument aside, most of us think of natural gas as a way to heat our homes. Well, whether you like it or not, the housing boom put many Americans in larger homes. It takes a lot of natural gas to heat those mansions.

The last point I’ll make about natural gas’ inevitable price climb is its environmental effects. Most people don’t know this, but natural gas is one of the cleanest burning sources of energy we have at our disposal. Take a look at this chart:

Okay so natural gas is going to go up. But, how do you profit? Well, in a previous article, Nick Jones offers Delta Petroleum Corp (DPTR: NASDAQ) as a solution.

That’s a bit expensive for our tastes, even if it is the solid company Nick suggests it is. It weighs in at a little over $2 billion market cap, selling at about $22 a share. So let’s look at a few that fit our parameters:

• Aurora Oil & Gas Corporation (AOG: AMEX) — This is a very small $60 million company with the majority of its stake in Michigan, Indiana and Kentucky. It’s an early stage production company. While it has been growing at a phenomenal rate, it’s still a risky investment.
  
• Edge Petroleum Corporation (EPEX: NASDAQ) — Edge comes in at $4 and change per share. About three quarters of the company’s production comes from natural gas along the Gulf coast. This is also a high growth opportunity. Year-end earnings come out on Thursday. We’ll be keeping our eye on this one.
  
• Grey Wolf, Inc. (GW: AMEX) — The Wolf is nothing more than a rig owner. The company owns rigs it leases to oil and gas companies. The majority of its customers are major natural gas drillers throughout the U.S. and Mexico. The company sells at slightly higher than $5 per share. We’ll continue to watch this one as its customer base grows.

While we aren’t recommending you buy shares of any of these companies, we do want to give you a clue as to what we look for in natural gas. We either want fast growing producers with large reserves, or specialist companies that can feed off of the rising prices without any of the risks associated with production.

In any case, we will continue to watch this market. I see a lot of good things coming from it down the road.

Sincerely,

Jim Nelson
March 11, 2008

P.S.: Chris Mayer has been following this story for quite a while. He was one of the first of us to come to conclusion that natural gas is going to skyrocket. He recently gave his readers a special opportunity that he calls the “The Biggest Resource Breakthrough Since the ‘Beaumont Miracle’ of 1901.”Editor’s Note: The gas companies listed above were recommendations from our readers. If you have anything to add or any other questions, you can always send them to us at jim@pennysleuth.com.

The Natural Gas Industry is About to Catch Fire was originally featured in the Penny Sleuth.

A warm winter doesn’t help the price of natural gas catch up at all with the price of oil. Warm winters mean that people use less of the stuff to heat their homes. It means higher inventories of natural gas. So even though the price of oil soars, the price of natural gas languishes. Old salts of the energy markets steer by the lights of a roughly 6-to-1 ratio between the prices of oil and natural gas. Today, that rate is closer to 13-to-1. Either oil is expensive or natural gas is cheap.

I think natural gas is cheap. I think it’s one of the best buys on the commodity menu right now. There are a few things that make me comfortable with the idea that those rich natural gas inventories won’t last much longer.

For one thing, as Grant’s Interest Rate Observer recently pointed out, Americans are living in bigger and bigger houses. Natural gas is a popular fuel to warm them. The amount of gas Americans use to heat their homes is rising per unit of cold. Grant’s quotes Leigh Goering, who runs a natural resource fund for Chilton. Goering says, “We’ve reached a point where we need warmer-than-normal winters for the system to operate properly.” And if the forecasters are wrong and we get a good old-fashioned cold winter? The imagination reels. Suffice to say, the price of natural gas will rise.

The size of homes was an interesting angle I had not considered before. It’s like an echo (or an aftershock) of the housing boom. The great housing bubble financed bigger and bigger homes that are costlier to live in. Even though the boom has turned to bust, its effects will linger on as a drag on America’s pocket books for years to come.

The second big issue is the new energy bill, which was kind to ethanol, to put it mildly. The bill requires a five-fold increase in ethanol production by 2020. The popularity of ethanol is one of the best things that ever happened to the natural gas industry.

That’s because ethanol is a great natural gas guzzler. Most ethanol distilleries burn it to make ethanol. And we have many new ethanol facilities coming online in 2008 — the vast majority of them will burn natural gas. But there’s more. American ethanol producers also need a lot of corn. Corn is also the biggest consumer of fertilizers among the big row crops. Fertilizers can make up 40% of the cost to produce corn. And some 90% of the cost of fertilizers depends on the price of natural gas. It’s a double whammy. Making ethanol itself burns gas, and producing the corn burns even more of it.

Finally, there are a number of new utilities coming online that burn natural gas. In 2000, nearly 95% of the new electric capacity in the U.S. burned natural gas. This has lead to a surge in natural gas usage post-2000. (See nearby chart titled “Natural Gas — Running a Hot Second.”) Since natural gas burns cleaner than coal or oil, it’s in an enviable position in a world suddenly highly conscious of its carbon emissions:

Add all that up and you’ve got a healthy backdrop to the demand for natural gas.

Sincerely,

Chris Mayer
February 25, 2008

P.S.: This is a theme that I introduced to my Capital & Crisis readers last year. We have already seen one of our natural gas plays shoot up 36% in just a few months. But we aren’t done yet. I expect to see that one rise even further as people start to realize this trend.

The Market is Severely Undervaluing Natural Gas was originally featured in the Penny Sleuth.