With Thanksgiving upon us, we’ve arrived at the busiest travel period of the year.
And as people hit the road en masse, the spike in gasoline consumption will again prompt talk about oil and gasoline prices.
It comes as the price of oil is rising again – a development that will ratchet up the talk in another area, too: Alternative energy.
Trouble is, despite the fact that population growth is leading to higher energy consumption, America is struggling to break its addiction to oil and make significant progress in other energy areas.
However, we do have an abundant supply of one fuel source…
Four reasons why natural gas prices are languishing
For all the talk about solar and wind power, the United States has a massive amount of natural gas.
Yet given our need for energy sources other than oil, we’re not using it as much as we should. And while every other commodity under the sun has rallied to hit new 52-week highs, or even lifetime highs, natural gas prices sit near all-time lows. In fact, the price is at the same level from a decade ago. Even lower if you adjust for inflation.
Why?
- Supply exceeds demand.
- We haven’t had major weather disturbances over the past five years (for example, hurricanes in the Gulf of Mexico) that have affected natural gas production. As such, the risk premium has decreased.
- New natural gas reserves continue to increase – both in the United States and worldwide.
- Energy lobbyists continue to favor oil, which has a more established base and consumer infrastructure.
While our natural gas usage is lagging at the moment, that will change – and when it does, the price will scoot higher. In fact, the change is already underway…
Favorable production costs keep profits churning for natural gas companies
If you look behind the scenes, major energy players are beginning to scoop up natural gas companies. And not little ones either.
The biggest deal came when Exxon Mobil (NYSE: XOM) bought XTO Energy for a whopping $41 billon in 2009 as a way of boosting the company’s natural gas reserves.
What’s even more impressive is that while natural gas prices languish near lows, companies like Encana Corporation (NYSE: ECA), the massive Canadian natural gas company, and Oklahoma-based Chesapeake Energy (NYSE: CHK) are able to make money and see significant positive cash flow.
The reason is simple: These companies are able to get natural gas out of the ground for far less than the price at which they sell it. Not only that, drilling and extraction costs aren’t expected to increase substantially for years.
So how do you make money from this undervalued sector?
Best way to trade natural gas: Get the price you want… and get paid, too
For a natural gas trade to work, you need to see three things:
- Increased demand for natural gas.
- Wider acceptability of natural gas from consumers. That includes a better infrastructure for natural usage in vehicles.
- Stronger government push to get off the oil standard.
Once these factors are in place – and we’re close to seeing all of them – the price of natural gas will move higher.
Right now, however, the best way to play this undervalued market is through a put-selling strategy on the major companies within the sector. This will allow you to build up a position in natural gas at very low prices… and get paid for trying.
Take one of the companies that I just mentioned, for example – Encana. The April 2011 $26 put options are currently trading around $1.25, so if you decided to execute a put-sell on it, you accomplish two things…
- By selling 10 put option contracts worth 1,000 shares, you’d collect $1,250 in your trading account ($1.25 multiplied by 1,000 = $1,250).
- Your net price for those 1,000 Encana shares would be $24.75 – beneath the stock’s 52-week low of $26.02 and about $3.60 less than the current price of the stock. And you’d only have the shares put to you (i.e. you’d be obligated to buy them) if the stock closed at or below the $26 strike price by expiration.
(Please note that this is just an example of a put-sell trade, not a specific recommendation that we’ll be tracking.)
Selling puts on companies that you want to own – but at your priceand getting paid for doing so – is one of the shrewdest investing strategies around.
Disclosure: The author does not hold positions in any of the stocks mentioned