Natural Gas is the Next Big Thing

Why is Natural Gas such a cheap commodity (3.87 cents per mmBTU, as of today), while Oil is increasing in price? This is a major disconnect and does not make any sense in the long-term. In West Texas, the ratio of crude oil to Henry Hub natural gaz has been approximately 8.5-1. It is currently at a historical ratio of 19 to 1.

Natural gas should cost around $8.47 per barrel with oil at $72 a barrel. If the oil price stays the same, that’s a potential 125% jump in natural gas price. Many experts believe that oil prices are fair right now given the costs of exploration, extraction and production.

UNG is a pure play on the price for natural gas. This ETF uses natural gas futures as its base and moves in line with the price. UNG trades at $14.50 today. However, it would trade for over $30 if natural gases normalized their pricing to oil. In the intermediate term, natural gas has great upside potential based just on its relative value. However, it is an even more attractive play over the longer-term (1-5 years).

President Obama will be accompanied by the Democratic-controlled Congress to pass some kind of environmental legislation either this year or in the near future. It is directed directly at carbon and its role (or the theory thereof) as it is not conclusively proved. The next several months will see the passage of either a “Cap and Trade”, as well as a straight-up carbon price. The majority of the heavy industrial sector and Congress moderates are facing the reality of some kind of legislation. They support a carbon-tax because of its simplicity and the fact that it can be passed on to the consumer more efficiently without any distortion or potential fraud.

Either scenario is very appealing. Canada Natural Gas per BTU energy is far cleaner than either coal or oil, the primary fossil fuel alternatives. This means that natural gas will become more competitive if legislation is passed to tax carbon emissions. It should have a lower historical relationship to oil than 8.5. If it is 7.0, the relative price for natural gas would be $10/mmBTU.

It will be used to transition to renewable energies like wind, solar and geothermal. T Boone Pickens supported the idea of natural-gas powered vehicles. He has even spent a substantial portion of his fortune on it. Fuel cell powered vehicles will become feasible within 10 year with government encouragement and subsidy. Then, natural gas will likely be used as the fuel of choice for such vehicles. Pickens can help existing fuel stations to include natural gas in their product offerings at the pumps, which will encourage people to embrace this reality.

These pure hydrogen vehicles offer a more sustainable option because they are made from pure water. There are still many problems in science, engineering, production, and manufacturing related to the manufacture, storage, distribution, and distribution highly combustible H2O.

So how can this megatrend benefit us?

Canadian Canroys can help you anticipate this new trend. North American natural gas is concentrated in Canada’s western regions. I was a Pennwest (PWE), Pengrowth, (PGH), Provident(PVX), Daylight(DAYYF), Baytex or Harvest Energy owner and beneficiary for many years (until that moment when the entire commodity system crashed to the skids). Anadarko Chesapeake and XTO, Southwest Energy, Lynn Energy are just a few of the U.S.-based producers. While all these companies offer decent dividends, they aren’t nearly as attractive than a year ago so it is not as tempting to buy and keep as in the past.

To increase leverage, you can sell “In-the-money” UNG put options at the October $18 price (UNEVR), which is approximately $4.50 per share. The stock price today is $14.50. This purchase provides $3 of upside and downside protection. If the price rises above $18 on October 16, these puts will expire and be worthless. However, you will still keep the $4.50 premium. For this to occur, the stock prices of the UNG ETF should only rise by $5.00 to the $4.00 current price. To lock in profits, execute a Buy to Close order whenever the premium falls to $2. This allows for a 500% return over six months.

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