Why You Should Buy 2040's Best Natural Gas Stocks Now

Richard Robinson's picture

Friday, April 28, 2017 - 2:30pm

by Richard Robinson

Anyone who knows me knows that one of my favorite investing techniques is to find a trend to follow. Once found, I stay with it as long as possible.

Of course it helps to find the trend early, too.

But finding an early trend can be difficult. For example, finding an actionable trend in natural gas seems almost impossible. As you can see from the chart below, the median price of natural gas has trended around the $2.50 range for the past 18-months.

best natural gas stocks

And this lack of positive momentum in the price of natural gas makes gas stocks unattractive.

But here's the thing: Natural gas prices are at the beginning stages of a long-term trend that will prevent them from staying this way.

Here's Why
While natural gas averaged $2.51 in 2016, the U.S. Energy Information Administration (EIA) estimates average prices will rise to $3.55 in 2017. This bodes well for natural gas companies as well as companies moving product across the United States and the globe.

EIA predicts that commercial use of natural gas will rise by 6 percent in 2017. Even so, those kinds of numbers are not a trend that investors can ride to huge profits.

But if you dig deeper into the EIA report, you'll find that the EIA projects natural gas generation will increase by 26% between 2016 and 2030. That number grows to 44% by 2040.

What's behind these numbers? Two primary trends will force natural gas prices higher. First is the approval of 10 projects to export natural gas by the Federal Energy Regulatory Commission (FERC). These projects will move upwards of 15 billion cubic feet per day (Bcf/d). That's roughly 20% of 2015's total gas production. Another 20 applications are pending federal approval, which could take another 25 Bcf/d to global ports of call.

In analyzing the impacts on natural gas prices from exports, the EIA estimates that by exporting just 12 Bcf/d will force natural gas prices to rise by $1.60. Should the government approve the export of another 25 Bcf/d, they estimate prices could approach $5.00 as early as 2020.

Now that's a trend investors can get behind!

But wait, there's more…

Despite Donald Trump's call for a truce on coal, it won't happen. Coal-fired power plants will continue to be retired. Nearly 18 gigawatts (GW) of electric capacity was retired in 2015 and another 40 GW worth of coal-fired plants are slated for retirement through 2040.

On the other hand, the EIA reports that 121 GW of electrical capacity is coming to the grid by 2040 -- all of it from natural gas.

That makes natural gas a trend every prudent investor must get behind.

Here's How
Buying into any trend is problematic. If you get in too early, stocks can show a lot of volatility before a new trend is firmly established. To avoid this situation, investors must find stocks insulated from high volatility while the new trend solidifies.

A great example of a natural gas stock with just such an ability to withstand volatility is Antero Resources (NYSE: AR). Antero is a natural gas producer with low-cost assets and dependable cash flows.

Take a look at the chart below to understand why its cash flow is so dependable despite the volatility of natural gas prices.

best natural gas stocks

As you can see, even at natural gas prices under $2 per thousand cubic feet (Mcf), 29% of its locations generate at least a 20% rate of return. At $3/Mcf, that ratio climbs to 70% of locations. This is possible because AR hedged 96% of its 2017 production to $3.47/Mcf.

This means the company's cash flow remains dependable even as the spot price of natural gas fluctuates. In addition, this forward thinking provides investors the opportunity to let the long-term trend fully develop.

Simply put, Antero has the best combination of low cost production and reserves. It's a must-buy for any natural gas investor.

Merging To Grow
Another natural gas play is Rice Energy (NYSE: RICE). Rice has been on a spending spree of late, buying Vantage Energy for a cool $2.7 billion. The deal increases the company's 2017 production by an incredible 70% above last year's numbers.

best natural gas stocks

The acquisition increases Rice's Marcellus shale exposure by 55%. Nearly all (95%) of it is fully in the Marcellus region. Now, with its combined exposure to the Utica and Marcellus shale plays, the company expects to earn drilling returns of 80% and 100% at current gas prices.

And like Antero, the company has hedged 90% of its 2017 cash flow at prices well-above the spot price of natural gas. Again, this affords the company a steady cash flow while awaiting the long-term trend for natural gas.

Trend following can reap huge rewards for investors. But buying the right stocks in the right trend is even more important. Both of these stocks are solid plays to take advantage of the long-term trend coming to natural gas.

Risks To Consider: In the short-term, many producers are willing to pull gas out of the ground at prices higher than the spot price of natural gas. This could lead to a glut of gas that forces prices lower in the meantime. But in the end, these companies risk their own financial health by doing do. Well-run companies like Antero and Rice can ride the volatility in gas prices.

Action To Take: Buy shares of Antero Resources and Rice Energy up to $25 each. Mitigate your risk by using no more than 2% of your portfolio to each of these stocks. These are long-term holds, and as such, require a 25% trailing stop.

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does not personally hold positions in any securities mentioned in this article.
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