2 Stock Picks For The Rise In Natural Gas Prices

May 14, 2012  |  includes: CLNE, CQP, D, KMI, KOL, NUCL

Natural gas prices have been on a sharp rise over the past month -- seethis Washington Post story for a deeper look. Here is an excerpt:

The price of U.S. natural gas jumped to the highest level since February as companies shut down production across the country.

Natural gas futures rose 2.2 cents to $2.487 per 1,000 cubic feet on Thursday, extending a recent surge. The price has soared 30.4 percent since hitting a 10-year low on April 19.

Here is a chart to put things in perspective.

(click to enlarge)

As I noted in my previous article on natural gas bottoming, I consider it likely that prices will trend much higher in the years to come. I would not be surprised to see the price end up around $4.50.

So, what are the consequences here for investors? Well, the first deduction that comes to mind is that higher natural gas prices makes natural gas vehicles less appealing. Higher fuel prices are bearish news for companies like Clean Energy Fuels (CLNE), which aims to build an infrastructure of re-fueling stations for natural gas vehicles (see my previous coverage); if natural gas becomes too expensive and thus less appealing as a fuel source relative to other options, companies like CLNE may run into some trouble. I believe it also strengthens the case for other energy sources -- namely coal (KOL) and my personal favorite, nuclear (NUCL).

But for those looking for natural gas companies that can profit even as natural gas prices rise, the opportunity to take advantage of is in US companies that can export cheap liquefied natural gas from the US. This opportunity won't last forever; eventually, as natural gas prices and as the market for liquefied natural gas becomes more competitive, margins will erode. But I think we are still in the early phases of the market for LNG exports, and so I think there is still plenty of time -- years -- to get in on the opportunity.

There are two companies I think those looking to play the opportunity in exporting LNG worth considering: Cheniere Energy Partners (CQP) and Dominion Resources (D).

1. Cheniere Energy Partners. Cheniere has a first mover advantage here, in that it just received approval for the first LNG export terminal in the lower 48 states in the US. As LNG exporting from the US is a new market, I think the first mover advantage is critical. However, the company's balance sheet is cause for concern; it has a current ratio below 1 and more debt than assets. As a general rule of thumb, this is a deal breaker for me; especially in our current environment, in which debt crises are everywhere, a company with solvency issues is one I'll personally pass on. But for those who are comfortable investing in companies with high levels of debt, CQP certainly has a lot going for it. In addition to its first mover advantage in a growing market, the company also boasts a pretty impressive dividend yield of 6.59%. As one who anticipates a formal announcement of QE3 (and likely subsequent rounds of QE, perhaps via a different name) and a bond market that will react negatively to such news, I think dividend-yielding stocks in promising sectors are positioned to do very well.

2. Dominion Resources. Dominion is a bit more of a company that suits my fancy; its got positive earnings and a dividend yield of over 4% at the time of this writing. It also has a low beta of just 0.46 -- so those who fear market volatility will find it comforting -- while trading at approximately 2.47X book value, a metric value investors like myself will find delightful. The company is working towards getting into the LNG exporting business, but has encountered some opposition from those claiming to be environmentalists. Because of the economic opportunity that exporting LNG can bring to the desperate US economy, I don't expect Dominion's efforts to be stopped in the long run.

I've previously stated that investing in pipeline companies like Kinder Morgan (KMI) is a great way to play the natural gas boom in the US. I still agree with this, and think the pipeline business is complementary to LNG, although I think the company that can manage to become to the top US exporter of LNG will bring shareholders some of the best returns in the natural gas sector.

By Simit Patel

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.