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3 Ways To Invest In The Coming Rebound In Natural Gas

 February 01, 2012 10:23 AM
 


As I laid out in my deep look at the changing dynamics in the natural gas sector (click here for Part 1), the entire industry may soon start to rebound as a falling rig count eventually leads to falling output, which in turn should help bring supply down to a level where natural gas prices firm up.


What kind of snapback can investors expect?

Well, a return to the glory days of 2008, when natural gas briefly touched $13 per thousand cubic feet (MCF) seems nigh on impossible. It's simply hard to envision a scenario where natural gas is once again scarce -- at least in terms of any reasonable investing time horizon. Still, a clear case can be made that supply and demand will be in rough equilibrium, perhaps as soon as a few quarters from now if the falling rig count finally starts to curtail output.

Natural gas currently trades for around $2.70 per MCF.

As a rough framework:

• A sharp drop in temperatures in the U.S. Northeast in the second half of this winter would quickly push gas above $3.
 
•  A drop in the rig count to around 725 or even 700 is probably good for another $0.50 move.

• Further conversions in multi-fuel power plants from coal to natural gas is another clear, but hard-to-quantify catalyst.

• And legislation that advances the opportunity for natural-gas powered vehicles  could add $1 to natural gas prices.

Add it all up, and natural gas prices could be trading between $3.50 per MCF and $4.50 per MCF a year from now. Goldman Sachs believes an inflection point is at hand and sees a slow rebound in natural gas prices to $3.75 by the end of this year, $4.25 next year, and $5.50 by 2014 as supply finally drops to appropriate levels.

In case you're wondering where the downside exists, industry-wide cash costs average about $2.30 per MCF. Any price below that and production would HAVE to fall. In any event, prices appear to have already bottomed in the current $2.60 to $2.70 range.

If the upside scenario plays out according to plan, here are three stocks that would surely benefit...

1. Chesapeake Energy (NYSE: CHK)
No one would be happier to see gas prices rebound than Aubrey McClendon, CEO of this beleaguered industry giant.


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