Investments that will be profitable once natural gas prices “recover” are, frankly, a dime a dozen. That’s because natural gas prices have managed to stay incredibly low for a very long time — and most natural gas investments have stayed low with them. Today’s recommendation, on the other hand, has actually held up well over the past few years. Below, Sound Advice’s Gray Cardiff explains why flexibility makes this fund his preferred play on natural gas prices.
“The price of oil — the world’s benchmark for the cost of energy — is north of $100 per barrel again. One barrel of oil provides approximately 5.8 million British Thermal Units (BTUs) of energy. (This value is approximate because various grades of oil have slightly different heating values.) So if a barrel of oil is say, $100, that is the cost of 5.8 million BTUs of energy.
“On the other hand, the market price for natural gas today is $2.27 for one million BTUs. To buy 5.8 million BTUs will cost $13.17 (5.8 x $2.27). So the same amount of energy is available for approximately 13.17 cents on the dollar — if it is in the form of natural gas.
“As the chart below shows, this is not a normal situation. The red line shows the price of a barrel of oil since the mid-1970s. The blue line shows the price of natural gas multiplied by 5.8 to approximate the same amount of energy contained in a barrel of oil. Note that for most of the time (36 years), the two forms of energy are closely aligned. This stands to reason. After all, energy is energy, and it should cost approximately the same regardless of the form in which it comes. However, that is not the case today. Note the current yawning gap between the costs of these two forms of equivalent amounts of energy. For 5.8 million BTUs, it costs approximately $100 if it is the form of oil, but only $13.17 in the form of natural gas. ...
“One explanation for the disparity is the fact that the market for oil is a world market, where the market for natural gas is not. Oil is transportable, which makes its price subject to the world’s supply and demand balance. Natural gas is not as readily transportable around the world because it first must be liquefied by maintaining its temperature at negative 260 degrees Fahrenheit. Therefore, natural gas is more of a continental market.
“The U.S. market for natural gas is currently glutted. An unusually warm winter has been suppressing demand while production has increased. Prices have been trading at their lowest levels in many years. Take a look at the above chart. ...
“Still, energy is still energy. To the extent one form can be substituted for another, the price per BTU should be approximately the same.
“There is an extensive infrastructure of pipelines across the U.S. to deliver natural gas, certainly within every metro area. Fifty-five percent of all U.S. homes are heated with natural gas. That still leaves nearly half that are not, and the conversion is relatively simple and inexpensive. When it comes to generating power, 31% is generated by natural gas in the U.S., but the rest is not. Natural gas has 30% less harmful emissions than those come from oil, and 45% less than those from coal. And Japan’s unfortunate nuclear accident has cast a pall over developing more sources of nuclear energy for the foreseeable future.
“The US is self-sufficient in natural gas, with only 9% imported from Canada. At approximately 13 cents on the dollar versus oil, natural gas is bound to have a growing role in America’s energy needs as well as independence from importing oil.
“The question then becomes how to invest? Some think the purest investment is an ETF, the United States Natural Gas Fund (UNG), that supposedly tracks NG prices. Instead, it relies on futures to play energy prices virtually. But futures do not track spot prices and can be distorted by trading strategies. There’s another ETF, the First Trust ISE Revere Natural Gas ETF (FCG), that tracks a changeable index of natural gas exploration and development companies, but we prefer a vehicle with more flexibility.
“This brings us to the only mutual fund that concentrates on the natural gas industry, the Fidelity Select Natural Gas Fund (FSNGX), one of Fidelity’s stable of tightly focused sector funds. The fund has a relatively new manager, Ryan Oldham, who has been at the helm since mid-2010 and who is no stranger to energy. He worked as an analyst for Canadian energy companies and global exploration and development firms.
“When the fund’s management is bullish on natural gas, the fund will emphasize more price-sensitive sectors of the industry — which include energy services along with exploration and production companies. When pessimistic about gas prices, the fund will turn to more defensive sectors of the natural gas industry, such as pipelines, utilities and integrated oil companies.
“The fund’s current top holdings represent a cautiously optimistic position. The two largest holdings are Apache Corp (APA, 11.4%), and Anadarko Petroleum (APC, 11.2%). These are both independent producers that generally offer better appreciation potential than shares of integrated companies. Yet they are established companies with financial strength and interests in both oil and natural gas.
“The next largest holding (9.1%) is Duke Energy (DUK) which is a holding company of utilities — clearly a defensive position. The Williams Companies (WMB) is the fourth-largest holding (6.4%), which gathers, processes and transports natural gas throughout the United States. This company is well positioned to fill the growing demand for new infrastructure to capture new supplies of domestic natural gas. ...
“Although natural gas prices have declined since the first of the year, this fund is up 6.9% — evidence that the investment strategy of this fund is working.
“This is an excellent time to add FSNGX to your portfolio. If you already own this mutual fund, we are recommending you add to your position.”
- Gray Cardiff, Sound Advice, March 12, 2012