In fact, after touching $2.00 in late 2001 and early 2002, the resource began a nearly four year bull run that took it to an all-time high near $16 in late 2005.
But this time it is different...
Most investors are aware that the hydraulic fracturing or “fracking” boom has made the US the Saudi Arabia of natural gas. That may be true, but the problem is that it’s coming out of the ground faster than it can be used, and storage is at a premium. This suggests that natural gas is likely to stay cheap for a long time, and that can be a huge boon for certain companies.
Let me explain...
Some of the biggest players in the commodity futures markets are “commercial hedgers”. There are two types of commercial hedgers:
The first are companies that either have a commodity or will have a commodity in the future and want to ensure that they have a buyer for their supply down the road. For natural gas, these are the producers like exploration and production companies.
The second are companies that have a need for a natural gas for use in production of whatever product they make or service they offer. They have an ongoing demand, and may include utilities, steel producers, fertilizer companies, etc. Natural gas may be an energy source or it may actually be used as one of the product inputs. Until those companies actually need the gas, they need to store it somewhere, pay someone else to store it, or take their chances in the spot market.
Storage costs make up a large part of the price difference between the current or spot price and the future prices. As you can see in the chart below, it costs nearly twice as much for nat gas delivery in two years as it does to buy natural gas for immediate delivery.
That is a huge 100% difference, reflecting the abundance of current and future supply as well as the lack of storage. The companies that use natural gas are beginning to shy away from locking in future deliveries and are more willing to take their chances in the spot market.
With plenty of supply, two companies in particular are poised to benefit from cheap natural gas.
Growing your wealth
There is a fact that may seem like it has nothing to do with natural gas, but it provides these stocks with another tail wind as the price of natural gas slips.
The world’s population is growing and, as a result, requires more food. And that means more crops. Supporting this is a USDA estimate that record crop growth in the States and globally is expected during 2012.
What do you need as crop plantings increase? Fertilizer.
There are basically three types of fertilizers: phosphate based, potassium based, and nitrogen based. Phosphate and potassium fertilizers are often mined in the form of potash, but nitrogen based fertilizers need to be manufactured, and that is where natural gas comes into play.
Without getting into organic chemistry, nitrogen based fertilizers are manufactured by removing the ammonia from the natural gas and adding nitrogen from air. Additionally, natural gas is often used as the energy source to remove the ammonia.
This is a double plus for nitrogen fertilizer companies, since a significant input for the process is becoming cheaper. These two companies have already benefited from declining natural gas prices, but stable low prices will likely enable these companies to continue to expand margins over the year.
The first is CF Industries (CF), which is up approximately 18% year to date, and almost 50% since its October low. After a spike in January, the stock has been consolidating between $170 and $190. The key is that it derives nearly 80% of its revenue from nitrogen fertilizers. Since nat gas is a primary input in its manufacturing process and plenty of supply exists as far as the eye can see, the ability to improve its processes into a backdrop of increasing demand suggests that margins can improve. It will next report earnings in mid-May, and this could be the catalyst for CF to break resistance in the $190 area.
The second is Agrium (AGU), which derives approximately 30% of its revenues from nitrogen fertilizers. A slightly larger portion of revenues comes from potash and potassium fertilizers, adding some diversification to the product mix while still providing it the potential to benefit from low and stable natural gas prices. AGU is also up solidly in 2012 and has begun to consolidate in the $85-90 range. This company will also report in mid-May.
Both stocks pay a token dividend of less than 1%, but if margins continue to expand then the payout may as well. Both of these fertilizer stocks have room to grow, and may soon provide an additional payout or buy back, giving investors an opportunity to grow their wealth.
Price Shock Trader