Natural gas: A potentially timely energy investment

Dave Gilreath: ©Sheaff Brock Investment Advisors

Energy investments involve issues of exploration and drilling, global supply and demand, infrastructure, refinement and distribution, and the imperfections of long-term weather forecasting. All these factors make this sector a horrendously complex investment.

Adding to this complexity is energy’s status as a commodity, subject to the vagaries of unpredictable price swings — way up one month, way down the next.

Yet for judicious investors using a highly disciplined approach, buying energy stocks can be well worth the effort. As in most investment fields, it’s a good idea to look for the bright lines that set apart investment categories with reasonable potential from those that don’t.

And currently, a bright line separates gas from oil: For a variety of reasons, now appears to be a propitious time to invest in natural gas as opposed to oil, especially for the long term and the ultra-long term.

Environmentally conscious investors are naturally averse to support fossil fuels, and natural gas falls into this category. But natural gas is less pollutive than oil and far less so than coal.

Investors are challenged by the difficulty of distinguishing investments in natural gas from those in oil, as the two are joined at the hip because they’re found in the earth together and extracted by the same companies. Yet some of these companies are more about gas than oil.

A factor that can limit investment gains is high global supply. Countries with the most natural gas include Russia, Qatar, Saudi Arabia and the U.S.

As with any resource, the effort and investment necessary to locate, extract, transport and transform it into usable products plays a big part in determining its value.

But along the way, there are companies that provide specialized products and services to these behemoths, just as smart vendors supplied picks and shovels to prospectors looking for gold in the Gold Rush; they made money no matter what happened.

The picks-and-shovels investing approach can get tricky with natural gas, as different companies are engaged in different matrices of services, and some of the huge energy companies handle various services themselves.

In general, energy companies are categorized as upstream (exploration and drilling), midstream (pipelines and refinement) and downstream (distribution).

By understanding what happens to natural gas along this journey from the ground to users, investors can equip themselves to make picks-and-shovels investments in infrastructure and equipment companies.

The industry is currently benefiting from a variety of drivers, including natural gas’s essential, growing role in replacing coal as fuel for generating electrical power. Natural gas is a powerful, lower-polluting alternative for this purpose.

It’s also an answer to the escalating demand for electrical power created by electric vehicles, all manner of rechargeable consumer products and devices, proliferating data centers with power-thirsty servers running consumptive artificial intelligence software, cryptocurrency mining and whatever comes next in this world of printed circuits bristling with chips that ravenously consume electrical power.

As the demand for power increases, the potential for existing electrical utilities to keep the power grid humming with enough juice is increasingly in doubt. This will likely mean more natural gas-fired power plants. Wind and solar power solve pollution problems, of course, but currently they’re supplementary power sources, at best.

Another answer is nuclear power, an industry that’s going through a bit of a renaissance after being mothballed for decades because of fear and public perception. Current advocates include influential voices like Bill Gates’.

New private nuke plants under development, to serve tech companies’ needs for high capacity from AI, have received attention. Modular nuclear power plants seem to have potential for replacing coal-fired plants.

Yet, even though changes in public perception augur well for this industry currently, the extremely long lead times for regulatory approvals, siting and construction make new nuclear plants for public power generation an extremely long-term solution. In the meantime, natural gas seems to be the clearest, most efficient and timeliest answer.

Perhaps the most compelling long-term case for natural gas lies not in the resource’s gaseous state but in its altered state as a liquid — liquid natural gas (LNG) — for export. After liquefaction at extremely low temperatures at specialized facilities, this resource is much more concentrated, and thus efficient to export in specialized ships.

Then, after arriving at foreign destinations, the liquid cargo is transformed back into gas — re-gasified — at specialized plants before delivery to users. LNG exports from the U.S. are projected to increase exponentially over the next 20 years.

Existing and anticipated global demand will likely drive natural gas prices higher over the next decade, and LNG exports are projected to account for much of this increase, according to a recent analysis by J.P. Morgan.

In the shorter term, analysts’ projections for natural gas in its naturally occurring, gaseous state are quite positive, based these factors:

• Commodity pricing fundamentals favor natural gas for 2025, particularly for mid- and downstream companies. One reason for this is that in the near term, the U.S. market is likely to be structurally undersupplied.
• A colder winter in the U.S. this year is increasing demand.
• Demand for natural gas for power generation will be increase from AI in some regions of the U.S.
• Electrical power-generation plants running on NG will get a boost from anticipated regulatory easing from the Trump administration (though the industry would prefer consistent regulation from one administration to the next).
• Switching from coal to natural gas at electrical power plants will continue to be a big driver for NG in the next couple years.
• Outlooks regarding NG, including export permit approvals and fast-tracking of projects, are highly favorable for this year. Much of this optimism stems from expectations that President Trump will reverse Biden’s permitting policies.

Natural gas infrastructure and equipment companies include:

Cheniere Energy (LNG), Kinder Morgan (KMI), EQT Corporation (EQT), ONEOK (OKE), Baker Hughes (BKR), Halliburton (HAL), Schlumberger (SLB), NOV Inc. (NOV),ProPetro Holding (PUMP), Patterson-UTI Energy (PTEN), Helmerich and Payne (HP), and MRC Global (MRC).

Though natural gas poses some research hurdles for individual investors, adding this energy investment may provide not only good long-term returns, but also helpful portfolio diversification.

Dave Sheaff Gilreath, CFP,is a founder and chief investment officer of Sheaff Brock Investment Advisors, a firm serving individual investors, and Innovative Portfolios,^® an institutional money management firm. Based in Indianapolis, the firms are managing assets of about $1.4 billion, as of September 30. Investments mentioned in this article may be held by those affiliates,Innovative Portfolios’ ETFs, or related persons.