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These 6 Oil Plays Are Still Pumping


With all the talk of natural gas and the ineluctable pull of King Coal, oil still matters and will for a very long time to come

With oil, growing global demand has prevented gluts even as supplies continue to expand. But gas is not a global commodity; it can't be easily trans-ported across oceans. Consequently, US production is much less influenced by energy demand from developing countries. And thanks to investments in new technologies, we are experiencing an historic gas glut that will take some time to resolve.

In 2005, the US economy was booming, hydraulic fracturing (fracking) was in its infancy, and experts were expressing concern about potential natural gas shortages. Energy companies began to invest huge sums into drilling for natural gas in formerly inaccessible reservoirs that new technologies such as fracking now allowed producers to access.

The result: Proven natural gas reserves (the amount of gas in the ground that is economically recoverable at current prices) have risen nearly 50% to 300 trillion cubic feet, equivalent to 13 years of US consumption at 2012 consumption rates, versus ten years a decade ago.

This glut, combined with the economic recession, caused prices to plunge to levels not seen in a decade. Now, gas producers are shutting down production and redeploying drilling rigs to continue oil production. In 2008, more than 1,600 rigs were drilling for natural gas; today that number has fallen to about 400.

The natural gas cycle appears to have bottomed out last winter, and gas prices should continue to strengthen, for several reasons. One is that transportation fleets are converting to natural gas. For fleet owners, the economics of switching to natural gas are very attractive, even if natural gas prices climbed as high as $7 per million British thermal units.

At current natural gas prices, oil would have to be priced at around $20/bbl to be as cheap on an en-ergy-equivalent basis as natural gas. That's why natural gas is likely to be a cheaper energy option than oil for years to come.

Demand for natural gas will also continue to increase for environmental and regulatory reasons, as utilities switch from coal to cleaner natural gas. In 2008, natural gas was used to produce 20% of America's electricity; this year, the natural gas share will reach 30%.

Meanwhile, growth in the use of liquefied natural gas (LNG) could increase demand for US natural gas, which would be more transportable around the world. Ambitious LNG export facilities are under construction, and while this market will take years to develop, it may be the next game-changer for gas.

But despite some rising demand, gas rigs can be easily shifted back into natural gas production as prices become more attractive to producers. Combined with the decade-long trend of rising natural gas reserves, that means low to moderate natural gas prices for several years to come. And it means few pure plays on natural gas production will be solid investments at this time.

That's not to say that some companies that produce natural gas aren't attractive -- for example, the aforementioned Linn Energy (which produces oil and gas) continues to thrive, thanks to smart hedging strategies.

Another way to bet on rising gas demand without exposure to low gas prices is to invest in a diversified master limited partnership whose business includes gas as an input, not just a product. One of our favorites is Enterprise Products Partners (NYSE:EPD), which remains a buy.

Editor's Note: This article was written by Robert Rapier of Personal Finance.

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No positions in stocks mentioned.
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