Have you ever stopped to wonder how much you are paying for energy, not per liter, not per kilowatt hour, but in MBTU (Million British Thermal Unit). By converting the price of gasoline, electricity and natural gas into $/Million British Thermal Unit I’ve discovered some interesting statistics which have interesting investment themes. Using some simple high school mathematics I’ve calculated the cost of different types of energy forms.
As a Canadian living in Ontario I pay the following prices for retail electricity, natural gas and gasoline:
36.50 $/MBTU Electricity Retail Price
34.56 $/MBTU Regular Unleaded Gasoline Retail
15.22 $/MBTU Natural Gas Retail
Which leaves us with the astonishing discovery that: Natural Gas Sells at a 56 percent discount to retail Gasoline
So in the long run there will be economic arbitrage between gasoline/oil and natural gas until both cost the same per MBTU. This implies that either Oil prices have to fall 50% in the long run or that Natural Gas has to rise 100% in the long run, or some combination in between. Personally seeing that Oil prices will rise over the coming years as demand grows while supply stagnates at best, Natural Gas prices are posed to double from the current NYMEX spot price of 7.87 $/MBTU in the long run .
Furthermore, Natural Gas is a North American commodity unlike Oil; 95% of Natural Gas consumed in North American is produced in North America. Seeing that production in the US has fallen since 2001 and production in Canada has fallen since 2004 and Mexican production is also falling higher prices are only be a few years away. This is problematic as Mexican consumption grows rapidly and as as Canadian consumption is growing rapidly due to Oil Sands demand.
Furthermore the building new LNG “Liquefied Natural Gas” import capacity is slow to progress and many years away.
Moreover a combination high inflation in the oil and gas industry and a high Canadian dollar has caused drilling to plummet in Canada over the last year further increasing the odds that we will see higher prices in the future.
The main reason we haven’t seen higher natural gas prices yet is the fact that warm weather have make above insignificant above ground supplies abnormally large, while the in ground supply as well as production rates have been decreasing.
Furthermore another reason the price of Natural Gas is lower is due to hedge fund pair trades. Hedge funds have been buying lots of oil on the markets while selling natural gas at the same time to hedge their position. This has pushed Natural Gas artificially low in front month contracts but high prices persist in future prices, resulting in a steep Contango effect.
With all these problems its hard not to be bullish on Natural Gas. There a 2 primary ways to play the natural gas story.
1) Buy the US listed ETF (AMEX:UNG) which is a basket of natural gas futures contracts.
2) The second and better method is to get exposure to natural gas weighted companies. In Canada, the energy trust sector is weighted more heavily to natural gas unlike the regularly structured corporations. In addition these companies have been hit by the future taxation of trusts in 2011 by the Canadian government. And topped off with the higher Canadian dollar most trusts have performed badly. However now i the time to buy them as natural gas prices have bottomed out and as the Canadian dollar is stabilizing.
Most trust have P/E ratios below 10, while trading at 1.5x book value (Exxon trades at 5x Book!), while boosting an average dividend yield above 11%. The following trusts are poised to outperform:
1) ARC Energy Trust (TSX:AET.UN) is a Buy
2) Peyto Energy Trust (TSX:PEY.UN) is aBuy
3) PennWest Energy Trust (TSX:PWT.UN) is a Buy
The trust outlined above are poised to succeed as they boost some of the highest margins and growth rates of in the trust sector while still being attractively priced on a P/E and P/B basis making them attractive targets for acquisitions and consolidation even if natural gas prices don’t increase. And even if they are not taken out they are safe and profitable businesses with secure distributions.
$26.11 (02/06/08)
