Fuel Your Portfolio with These Natural Gas Investments

A supply glut resulting from excess production from shale formations depressed natural gas prices in 2010.

Since then, persistent inclement weather last winter and a hot July in many parts of the U.S. spurred natural gas demand from power generators, while production cuts reduced supply. Currently, the inventory levels are 2% below the year-ago level and 2% below the 5-year average.

Going forward, demand ought to grow, mop up the excess supply and lead to hardening of natural gas prices. Power generators are switching to natural gas from coal and fuel oil. Petrochemical companies prefer natural gas liquids because of their current cost advantages compared to crude oil.

Two factors support our expectation for a rise in natural gas prices: The rising slope of natural gas futures contracts and activities of major players in energy and energy services.

Natural gas futures quoted at the NYMEX rise to $3.87 for December 2011 delivery from $3.62 per MMBTU for October 2011 delivery. They increase by 27% to $4.58 for December 2012 delivery and by another 9% to $5.01 for December 2014 delivery.

After the acquisition of XTO energy, ExxonMobil (XOM) is looking for expansion of its natural gas portfolio. Halliburton (HAL) is expanding its services for extraction of natural gas from shale formations and plans to add 11,000 jobs in the U.S. this year.

Industries That Stand to Benefit

Industries that stand to benefit from firming natural gas prices include those that are engaged in exploration & production of natural gas, energy services, storage & transportation of natural gas and processing & distribution of natural gas liquids. This opens up investment opportunities for both growth and income investors.

Investment Choices for Growth Investors

The investment choices for growth investors include stocks of specific companies in this sector. Two companies stand out for their growth potential.

Devon Energy (DVN) has restructured to become a high-growth onshore company. The company is the largest natural gas producer in the Barnett shale and has strengthened its dominant position here with liquids-rich assets in the Permian Basin. Devon has a well-defined program for increasing production. Strong cash flow from current operations should help the company fund future growth prospects. Devon Energy’s EPS is likely to increase 17% in 2012 and another 18% in 2013.

National Fuel Gas (NFG) is among the largest leaseholders in the Marcellus shale. Rise in natural gas production and sales are lifting the top- and bottom-lines of the company. The company is expanding its pipeline network to meet with the expected growth in demand for natural gas from power producers. NFG’s EPS is likely to increase 9% in 2012 and another 23% in 2013.

Investments in stocks such as those discussed above involve company-specific risks. Diversification across several natural gas companies reduces such risks. Investments in bundled products like sector ETFs and sector mutual funds including Fidelity Select funds provide diversification.

Growth-oriented mutual fund and ETF investors can look at Fidelity Select Natural Gas (FSNGX) and First Trust ISE-Revere Natural Gas ETF (FCG), respectively.

Investment Choices for Income Investors

Numerous master limited partnerships in the natural gas industry are involved in storage & supply of natural gas to power producers and processing & supply of natural gas liquids to petrochemical industries. These companies generally distribute a major portion of their income as dividends. Two partnerships in particular merit the consideration of income investors.

Targa Resources (NGLS) has access to Henry Hub, the largest natural gas hub in the U.S. This offers the partnership a competitive edge in natural gas storage & transportation and natural gas liquids processing & distribution in Louisiana and the southeast. Strong demand for natural gas liquids is providing ample growth opportunities for the company. The partnership has increased its dividend distribution by over 10% since 2009 and its stock currently yields nearly 7%.

Williams Partners (WPZ) supplies natural gas to power plants and natural gas liquids to petrochemical industries. Williams is expanding its pipeline capacity anticipating increased demand for natural gas from power producers. Strong NGLs demand is helping revenues in its midstream unit. While keeping an adequate cushion for pay-outs, the company has increased its dividend for 6 successive quarters. It expects to increase its annual distribution by 6% to 10% in 2011 and 2012. Currently, the partnership’s stock has a dividend yield of 5.4%.

JP Morgan Alerian MLP Index ETN (AMJ) and Alerian MLP ETF (AMLP) fit the needs of income-oriented ETF investors, while FBR Gas Utility Index Investor (GASFX) fits the needs of income-oriented mutual fund investors.