Is It Time To Invest In Natural Gas?

July 25, 2017

Is It Time To Invest In Natural Gas?

  • There are many influences on natural gas in the short term, but the long term is pretty clear.
  • Despite the growth in demand, there is no supply gap expected, and thus cost and moats should be looked for in potential investments.
  • As the long-term trend is positive, it’s a good thing to buy when there is pessimism in the sector, which is usually for a relatively short period.

Introduction

I recently wrote an article on oil where I discussed the implications of and best timing to invest in oil. A commodity that is closely related to oil is natural gas. However, the long-term supply and demand trends are a bit different than those for oil which make natural gas an interesting long-term investment opportunity.

The fear for oil is that car engines are becoming more efficient and more electric, thus lowering the aggregate growth in demand for oil. The attractiveness of natural gas lies in its relative cheapness and global need to lower coal usage in order to limit negative atmospheric emissions.

Many countries have as their goal to lower or eliminate their coal usage and replace it with sources that produce electric energy. Since the Fukushima nuclear disaster, the outlook for nuclear power plants has become more clouded while the skies have cleared for natural gas.

However, natural gas prices are still relatively depressed alongside oil prices. This isn’t good for those already invested in related assets, but it is good for those yet unexposed to such assets.

Natural gas prices fall under the influence of the weather in the short term as colder weather leads to more consumption and lower inventories. As the weather is unpredictable, it’s also very difficult to predict short term natural gas price movements. However, short term price movements create opportunities for the long-term investor as the long term natural gas trends are pretty clear.


Figure 1: Natural gas prices in the last 10 years. Source: Knoema.

Aside from the recent dip in prices, what’s also very interesting is the difference in natural gas prices across the world. The differences are because a big part of the natural gas cost is related to transportation. However, there are some companies, like Cheniere Energy (NYSE: LNG), that are betting on the situation remaining as is and want to take advantage of the low cost natural gas production in the U.S. by exporting liquified natural gas (LNG) to the rest of the world.

Let’s take a look at the long-term outlook for natural gas to see whether the trend is positive and whether the sector offers interesting long-term investing opportunities.

Long-Term Energy Outlook

The first recognized trend is global development. For example, the current global middle class, which is essential for energy consumption, is expected to double in the next 15 years.


Figure 2: Global middle class expansion. Source: XOM.

With global development and middle-class expansion, demand for energy is also going to grow as the middle-class population ignites demand for energy.


Figure 3: Energy use per capita in thousands BTU (British Thermal Units) vs. Human Development Index. Source: XOM.

As for energy sources, every government has a goal to lower emissions. As natural gas usage creates 75% less emissions than coal, it’s clear how it’s expected to be the fastest growing energy source in the next few decades, followed by nuclear and renewables.


Figure 4: Expected energy demand by sector – natural gas is the fastest grower. Source: XOM.

Natural Gas Supply & Demand

Demand for natural gas is expected to grow 45% by 2040, and in all regions except Russia.


Figure 5: Expected growth in natural gas demand per region. Source: XOM.

Despite the increase in demand, we can’t expect much higher prices coming from a supply gap because there is enough natural gas for the next 200 years since new technologies, like shale oil and gas drilling, expanded available resources.


Figure 6: There is enough gas for the next 200 years. Source: EIA.

However, Asia Pacific, Europe, and Africa are going to have to import the majority of their natural gas needs which creates interesting investing opportunities.


Figure 7: Global import export projections for natural gas. Source: XOM.

All of this global trade is going to benefit low cost producers and natural gas transporters.

An industry expected to boom in the next few decades is LNG (liquified natural gas). When liquified, natural gas uses 600 times less volume, and is thus easier to transport.


Figure 8: Expected boom in the LNG industry, especially U.S. exports. Source: XOM.

The fact that the U.S. will become the largest LNG exporter in the world provides me the necessary logic behind Seth Klarman’s investment in Cheniere Energy, his largest U.S. portfolio position. If you haven’t read our analysis on Seth Klarman’s portfolio, the article is available here.

Conclusion

Demand for natural gas is definitely going to grow. However, the asset doesn’t provide any kind of boom upside as is the case for copper where a significant supply gap is expected. In such a scenario, there is still money to be made by investigating the lowest cost producers, companies with a moat that have a strong market position, like potentially Cheniere has with its projected 7 LNG export trains.

Another outcome of this research is that Russia is, and is going to remain, a strong natural gas player in the future, so there might be interesting opportunities there as some of their companies are trading close to multi-year lows.

For those interested in doing more research, the top 10 natural gas companies are the following:

    • Gazprom (Russia)
    • Exxon Mobil Corporation (NYSE: XOM)
    • China National Petroleum Corporation (China)
    • Royal Dutch Shell (NYSE: RDS-A)
    • BP (NYSE: BP)
    • Total SA (NYSE: TOT)
    • Chevron (NYSE: CVX)
    • Eni SpA (NYSE: E)
    • Statoil ASA (NYSE: STO)
    • ConocoPhillips (NYSE: COP)

A good strategy might be to buy natural gas stocks when natural gas prices are low because of short term panics or the weather as there is a margin of safety coming from higher global demand.


Figure 10: Chevron’s stock price. Source: Nasdaq.

Chevron’s stock price shows significant drops every few years which are closely related to drops in natural gas prices.


Figure 11: Natural gas prices are volatile. Source: Forbes.