After a rough 2011, a number of commodity-related industries are beaten down as we head into the new year. While the potential for slowing growth overseas could keep many under pressure indefinitely, natural gas stocks look to be one sector poised for some upside in 2012.
The natural gas industry has underperformed the broader energy group in recent years, as a glut of supply from shale production has depressed the price of the commodity. While it’s not yet time to buy, this sector could represent an outstanding contrarian opportunity in the year ahead.
Click to EnlargeThe outlook for natural gas remains extremely cloudy in the near term, with warm weather exacerbating the already huge stockpile of the commodity. Nevertheless, the longer-term picture is starting to look more positive, which might create the opportunity for a bounce — or at the very least, a stabilization — in the price of natural gas in 2012.
If that proves to be the case, certain stocks in the sector appear to be in line for outperformance.
Support From Long-Term Trends
A positive long-term view on natural gas was put forth last week by ExxonMobil (NYSE:XOM) in its annual energy outlook titled “A View to 2040.” In it, the energy giant made a few several points that are favorable for the natural gas industry. Among them:
- By 2040, electricity generation will account for more than 40% of global energy consumption. ExxonMobil expects new, high-efficiency natural gas plants to play a major role in this increase. The company also predicts that the percentage of power generation from coal will fall from about 40% today to less than 30% in 2040.
- Oil will remain the most widely used fuel, but natural gas will grow fast enough to overtake coal for the No. 2 position.
- Demand for natural gas will rise by more than 60% through 2040, while demand for coal will peak and begin a gradual decline beginning in 2025, partly because of tougher regulations.
- Natural gas currently is the second-most commonly used fuel for residential/commercial purposes in developed countries, and by 2040 it will account for 30% of demand.
Another important development is that some of the supply pressures on the industry will be alleviated in the years ahead with the opening of the liquefied natural gas export terminal in Louisiana in 2015. Additional build-out of the export infrastructure is in the cards over the next decade, which should further improve the supply picture in time. This will allow U.S.-based natural gas companies to offload excess supplies to the overseas markets, where pricing is much more favorable.
Granted, all of this is a longer-term story and there’s plenty of time for further weakness in the sector in the immediate future. Still, the underlying fundamental trend is growing more positive, and this should provide longer-term support for natural gas stocks.
Already, the supply outlook is improving because of the sharp decrease in the rig count that has occurred in the past two months, which includes a decline in the Haynesville Shale. It’s also an important consideration that natural gas companies have learned how to operate in an environment of sub-$5 natural gas, increasing the likelihood that they will be able to capitalize when the price of the commodity finally begins to turn.
Where to Invest in Natural Gas
Click to Enlarge For retail investors, natural gas stocks remain the only legitimate option to play natural gas. While United States Natural Gas Fund (NYSE:UNG) and iPath Dow Jones UBS Natural Gas Subindex Total Return ETN (NYSE:GAZ) remain available as options, these ETNs have been a black hole due not just to the falling price of natural gas, but also the challenge of their having to roll continuously into higher-priced, later contracts.
Click to Enlarge Investors also have the option of investing in the First Trust ISE Revere Natural Gas ETF (NYSE:FCG), but this vehicle invests in all companies that drill for natural gas. As a result, it includes major weightings in stocks such as ExxonMobil and ConocoPhillips (NYSE:COP) and therefore doesn’t provide a pure play on the industry.
On this basis, individual natural gas stocks look like the best bet. While some names in the group have performed very well so far this year, others are candidates for a contrarian play in the year ahead. The table below illustrates some of the relative attributes of a few of the larger industry players.
To capture the most upside, consider looking at companies with a solid growth, ample reserves, low-cost production profiles, attractive P/Es and weak price performance. On this basis, the best bets in the group likely will prove to be Chesapeake Energy (NYSE:CHK), Southwestern Energy (NYSE:SWN) and Ultra Petroleum (NYSE:UPL). The potential for takeover activity is an additional source of possible upside in this group.
While this industry always should be approached with great care — especially now, with supply pressures remaining in place and oil and other commodities experiencing high volatility — the sharp downturn of the past week has rapidly brought the group to an oversold level. Look for opportunities to use any further weakness to capitalize on what might be one of the most interesting areas in energy in the year ahead.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities. Check out InvestorPlace.com’s other looks back at 2011 and ahead to 2012 here.
