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Published: September 20, 2010
Royal Dutch Shell said that by 2012 it expects more than
half of its output will be natural gas -- not oil. That is as if
Starbucks said it expects to sell more tea than coffee.
Yet this is not unusual for Big Oil these days. In fact, most
are making big bets on natural gas.
Exxon Mobil completed eight projects last year. Seven of them
were for natural gas projects -- not oil. Of the three scheduled
this year, two of them are gas. ConocoPhillips paid $5 billion
for Origen, an Australian gas company.
Meanwhile, Chevron hammers away at its mammoth liquefied natural
gas plant off the coast of Australia, at a total cost of more
than $40 billion. (Liquefied natural gas, or LNG, is easier to
transport.) Most of the oil giants are also slamming
billion-dollar fistfuls to pick up shale gas acreage in places
such as the Marcellus in Appalachia.
This shift creates new opportunities for investors. But before
we get to those, let's try to understand what's happening.
There are several things at work here. One is that new oil
deposits, like pitchers who can hit, are becoming harder to
find. They are also costlier. The Kashagan oil field, which was
supposed to be a great find in the Caspian Sea, is seven years
behind schedule and billions of dollars over budget. Another
factor at work is that 90% of the world's oil reserves are in
the hands of national oil companies. They are off-limits for the
likes of Exxon and others.
By contrast, natural gas deposits are more plentiful. They are
also getting cheaper to develop. The cost to build an offshore
LNG terminal is about half of what it was only two years ago.
The big LNG plants can be just as expensive as anything in the
oil world, but -- unlike oil -- these projects don't usually go
forward unless there are long-term contracts in hand to support
them. Some of these contracts go for 20-year terms. This makes
the business more appealing to the majors, who don't have to
sweat the huge ups and downs they endure in the oil markets.
With contracts in hand, the gas business is
just one of putting together an Erector Set. As The Economist
notes, "The gas business is really an infrastructure business:
drill wells, build gas plants, install pipelines and accrue
profits."
But there is more. The world's use of natural gas is growing
faster than its use of oil. The IEA's guess is that oil
consumption grows half a percent a year. Natural gas
consumption, by contrast, should rise more than 50% in the next
20 years. Total, the big French oil company, is even more
bullish. It estimates that China will use much more natural gas
than is commonly assumed. Only a lack of infrastructure keeps
China's appetite for natural gas under wraps. But China is in
the process of building that infrastructure today. It is only a
matter of time before the nat gas markets feel its impact.
Finally, natural gas is cleaner burning. There is a lot of talk
of carbon taxes of one kind or another, not only in the U.S.,
but abroad. I believe it is matter of when, not if, governments
punish dirtier fuels. Natural gas will benefit.
However, I don't expect the price of natural gas to rise in a
big way anytime soon. There is simply too much of it. Natural
gas producers are all expanding production. Most are spending
more to expand production than their cash flow supports. This is
happening even though most look like they don't make any money
at $4 nat gas. (A recent survey put the industry average at
$5.74.) This doesn't bode well for the price of natural gas in
the short term. As beaten up as it is, it could stay here for a
while, or even go lower.
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And so we hold only one pure play on natural because it is a
low-cost producer with no debt, so it can still create
shareholder value in a low-price environment.
Longer term, the current low nat gas price is not sustainable,
as most of the industry seems to lose money at these prices. As
old contracts (made when natural gas prices were higher) roll
off, these producers will start to shut down production.
The following chart shows the cost curve for the lower 48 states
in the U.S. These producers need $7 gas to make money. If this
is right, then our pure natural gas company in Capital &
Crisis will make a lot of money.
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This is because logic dictates that we should expect the
price of nat gas to gravitate toward the cost of the marginal
producers. (And since our company's costs are under $2, it
stands to make a lot of money when gas turns around. I'm content
to wait it out…and buy more).
But let's get back to natural gas in broad terms. Even though
pricing looks unexciting in the near term, demand looks healthy
long term. The world will burn more natural gas in cars and
buses of the future than it does today. It will burn more
natural gas to heat and cool homes than it does today. It will
rely more on natural gas to provide electricity.
Long-term investors should treat these things as inevitable. Big
Oil certainly is. And we are already building the infrastructure
to support all of that future growth today. The best way to play
this latter trend is in another idea we already own.
--Chris Mayer
Editor
Whiskey and Gunpowder
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Note: This article originally appeared on
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