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Gas Glut?
New York: March 29, 2010
By John Stephenson

Just a few short years ago, investors fretted that North America was running out of natural gas. Once viewed as a nuisance by the energy industry, natural gas is now a coveted resource. Natural gas is used to power electricity plants, to heat homes and businesses, as well as being a critical feedstock for the chemical and plastic industries. And while oil is priced as a transportation fuel, investor T. Boone Pickens has suggested that natural gas, rather than gasoline, could have a bright future fueling the nation's cars.

Back in 2007, with demand for natural gas surging and with the conventional gas basins running dry, natural gas prices suddenly spiked to above $14.00 per million cubic feet—an all-time high. Back then, one solution to North America 's dilemma of stagnant supply seemed to rest in importing vast quantities of natural gas in liquefied form (LNG). Companies such as America 's Apache Corporation, rushed to build massive LNG terminals to receive liquefied natural gas, re-gasify it and pipeline the gas to American industries. But today, we are drowning in a glut of natural gas and prices have slumped sharply and are now range-bound in the $4.00 to $5.00 per million cubic feet area.

What changed America 's natural gas fortunes was some pioneering work by a company called Mitchell Energy in a vast underground structure called the Barnett Shale near Fort Worth , Texas . Geologists had always known that unconventional formations, such as shale formations, contained vast quantities of trapped natural gas. But the problem for the industry was how to unlock the trapped gas economically. Rising prices for natural gas in recent years helped drive economies of scale for shale formations and when coupled with two technical innovations created a very big glut in natural gas.

Mitchell Energy was the first company to apply two techniques that were prevalent in the oil industry to the search for natural gas—hydraulic fracturing and horizontal drilling. Instead of drilling straight down into a natural gas reservoir, Mitchell's engineering team decided to drill across the reservoir rather than straight down, potentially unlocking previously inaccessible natural gas. They also used hydraulic fracturing techniques to split open the tight rock formations that held the gas trapped. The result was nothing short of staggering.

Overnight, the industry changed dramatically. Today, North America is awash in shale plays and in 2008 the U.S. became the second largest gas producer in the world. The abundance of North America 's natural gas reserves contrasts sharply with the narrowing opportunities that Western firms face elsewhere. Western oil companies are being restricted in oil-rich countries such as Russia and Venezuela , as high oil prices have emboldened the leadership to restrict foreign access to their oil fields.

The oil industry's majors have been content to sit on the sidelines as more entrepreneurial drilling companies proved shale's viability. But all that began to change in December 2009, as Exxon Mobil paid $41 billion for XTO Energy, a pure-play natural gas company with significant shale business. Today, BP, Total, Statoil and other large energy companies are sniffing around North America 's gas patches in search of a joint venture or an outright acquisition of a gas company with shale expertise. A wave of consolidation is likely coming in the next several months as low prices for natural gas have emptied the bank accounts of many shale gas players.

In theory, shale gas plays around the world should offer the same promise as America 's Barnett Shale. Already, drilling companies are arriving in China and Europe in the hope of transforming those countries into natural gas producing powerhouses. The International Energy Agency (IEA), a leading energy authority, has pegged the world's unconventional and shale gas reserves at 921 trillion cubic feet—more than five times proven conventional natural gas reserves.

But while a wave of consolidation could sharply lift the fortunes of investors in natural gas companies, I wouldn't bet on it. Gas is far too abundant and the stock prices of North American natural gas companies are discounting much higher natural gas prices than the current or “spot” price of gas, suggesting stocks for gas producing companies will fall in the future.

Energy companies that produce oil, rather than natural gas, are the preferred way to profit from a pick up in global economic activity. There is still far too much natural gas in North America to be a big believer in sharply higher gas prices any time soon. This is one area of investing where less really is more.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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