by Aaron Levitt | September 13, 2013 1:01 pm
In case you haven’t noticed, North America is in the middle of a natural gas revolution. New techniques in hydraulic fracturing and horizontal drilling have unearthed massive reserve potential across the continent. The energy industry has been tapping America’s shale at a rapid pace to take advantage of this potential.
That potential hasn’t been lost on end-users, either.
Utilities have switched to the cheaper and cleaner-burning fuel, while residential and commercial consumption continues to spike. In total, data supplied by the Energy Information Administration shows that, through May of this year, demand for natural gas increased by 3.6% on a year-over-year basis. That demand is only set to grow as the U.S. begins to export this bounty.
All of this potential for higher natural gas prices, earnings and production raises the question — just exactly how can the average investor cash in on this opportunity?
Here are five of the top ways.
Tracking 25 energy companies that derive a substantial portion of their revenue from the production of natural gas, the First Trust ISE-Revere Natural Gas Index (FCG) could be the top equity play on the theme.
Roughly 90% of the firms included in the equal-weight index are located in the U.S., with the remainder being Canadian. This includes exposure to heavy-weights like Chesapeake Energy (CHK) as well as smaller fries like Magnum Hunter Resources (MHR).
So far, that varied exposure to small-caps, mid-caps and large-caps hasn’t really helped investors. Since the fund’s inception back in 2007, returns have been a mixed bag. FCG has actually managed to produce a 1.74% loss versus a 4.99% gain for the S&P 1500 Energy Index. However, that result actually isn’t too bad considering it launched just before the recession, not to mention last year’s historic drop in natural gas prices.
The fact that FCG is still now trading below its IPO price could signal a major value for investors — especially considering the bullish tailwinds propelling natural gas higher. Expenses for the fund run 0.60% — or $60 per $10,000 invested.
The task of getting natural gas production to processing facilities and end users falls to a select group of firms that own all the pipelines and storage facilities dotting the North American countryside. There’s some big money to be made in providing and owning that vital infrastructure.
There are currently 16 exchange-traded funds dedicated to master limited partnership. However, their exposure varies on just what midstream infrastructure — if any at all — they hold. Yet, the UBS E-TRACS Alerian Natural Gas MLP ETN (MLPG) is the only pure way to bet on the MLPs that focus on natural gas.
MLPG tracks 20 different midstream firms who receive the bulk of their cash flows from the transportation, storage and processing of natural gas and natural gas liquids. This includes holdings in firms like Crestwood Midstream (CMLP) and Access Midstream Partners (ACMP). The exchange-traded note can provide a broad play on the overall need for more natural-gas-based infrastructure. The fund currently yields 5.02%.
It’s not based in Chicago, nor does it build bridges out of iron, but Chicago Bridge & Iron Company N.V. (CBI) could be one of the best ways to play the natural gas boom.
The engineering and construction firm is a petro construction powerhouse, with projects ranging from huge offshore/underwater pipeline networks in the North Sea as well as new chemical facilities here in the U.S. However, its biggest natural gas fortunes could lie with its expertise in constructing liquefied natural gas export terminals.
CBI is one of the leading plant builders and was tapped by Chevron (CVX) to help construct its massive Gorgon project in Australia. Four LNG export facilities have been approved in the U.S., and analysts say more will be coming as production volumes grow. As a leader in the field, CB&I could see itself winning more contracts to construct and modify these facilities. It could also win more pipeline contracts stemming from these facilities.
All of this will help build CB&I’s massive backlog as well as its earnings. Not that it really needs any help there — in the last four quarters, the firm’s earnings per share jump 14%, 30%, 37% and 39% year-over-year, respectively. CBI trades for a forward P/E of just 12.48.
While the United States Natural Gas ETF (UNG) remains the trader’s best friend when it comes to betting on rising natural gas prices, the fund has suffered big time from contango. ETFs based only on current prices lose money if a market is in contango because they have to buy the higher-priced, longer-dated contract and sell the cheaper spot month. So they are essentially selling low and buying high. Contango is constant and persistent problem in the natural gas sector.
However, United States Commodity Funds does offer a little known and perhaps better natural gas futures fund — United States 12 Month Natural Gas (UNL).
The ETF attempts to get around the contango problem by laddering its holdings with 12 months’ worth of natural gas futures. That helps smooth out the ride, but perhaps more importantly, leads to better long-term outperformance. UNL has managed to put up more impressive returns that its current future twin UNG.
Expenses for UNL run 0.75% and investors will get a K-1 statement come tax time.
If using futures to directly bet on rising natural gas prices isn’t your thing, then you may want to look at United States Royalty Trusts.
Royalty trusts — which differ in structure from their former Canadian cousins — generate dividend income from the development of natural resources such as coal, natural gas, and crude oil. These cash flows are subject to the prices of the underlying commodity. If natural gas is at all-time highs, the dividends will reflect that. With natural gas prices rising, the time could be good to pounce on some of the trusts focused on natural gas.
Holding an 80% royalty on natural gas properties in the rich Hugoton Natural Gas Area, the Hugoton Royalty Trust (HGT) allows investors to play one of the largest natural gas fields in the country. HGT has interests in properties located in Kansas, Oklahoma and Wyoming.
Originally set up by XTO Energy — before Exxon (XOM) snagged it — the trust has been steadily paying monthly dividends since 1999. Those dividends have been increasing over the last few months as natural gas continues feature prominently in the U.S. plans to achieve energy independence.
The downside is that HGT’s reserve-to-production ratio is only about 10.6 years. However, due to enhanced drilling techniques, the trust’s life may be longer. HGT currently yields a hefty 12.5%.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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