How the natural gas sector can still make you money

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Natural gas may be a wallflower among commodities, but some investors are making money in the sector despite depressed prices.

They're snapping up shares in companies that produce large quantities of so-called wet gases, such as ethane, propane and butane, which are often generated as a byproduct of drilling for dry natural gas.

Prices of these liquids tend to follow the lead of crude oil, now selling for more than $100 (U.S.) a barrel, so natural gas producers with a steady stream of liquid output can prosper despite the dismal outlook for natural gas itself.

"Some of the stocks that have gone up the most in our portfolios over the past year are ironically gas producers," said Joanne Hruska, a portfolio manager with Aston Hill Investments Inc. Among her favourite natural gas stocks are Angle Energy Inc., which has 40 per cent of its production in liquids.

Many natural gas producers are now deliberately searching for liquids as a way to offset extremely low prices for natural gas.

The low prices are the result of a glut of natural gas arising from technology that fractures rock to release gas trapped in shale deposits.

As shale gas has flooded onto the market over the past couple of years, prices for natural gas have plunged to about $4 per million British thermal units on the New York Mercantile Exchange, a far cry from the $15 level of late 2005.

Eric Nuttall, a portfolio manager with Sprott Asset Management LP, says oil used to trade for six to seven times the price of natural gas. Now the difference has swelled to 25 times, an indication that natural gas has become dirt cheap in comparison with liquid forms of energy.

Top Picks

As a result of the growing disparity in prices, a steady stream of liquids such as butane and propane can significantly improve the economics of natural gas plays, said Adam Twa, an analyst at Peters & Co. Ltd.

Stocks in this niche that he likes include Peyto Exploration & Development Corp. (12-month target, $23 a share), Tourmaline Oil Corp. ($33), Trilogy Energy Corp. ($24), Celtic Exploration Ltd. ($26), Progress Energy Resources Corp. ($17.50) and Cequence Energy Ltd. ($4.50).

Even though these stocks have had a nice pop - Cequence is up over 90 per cent this year - Mr. Twa still sees more upside because these companies have many years of inventory left in their liquid-rich plays.

"Those are still our top picks," he said. "They have good balance sheets and the management teams have very successful track records of executing."

The momentum in these plays is evident in the BMO Junior Gas exchange-traded fund (ETF) , which is up about 20 per cent this year. The 37-stock ETF tracks some liquid-rich gas names like Celtic Exploration, Trilogy Energy, Angle Energy, and Delphi Energy Corp.

Natural gas companies without exposure to natural gas liquids have not fared so well. The stocks of Perpetual Energy Inc. and Ember Resources Inc., for instance, are in the red over one year.

Sprott's Mr. Nuttall, who is "quite bearish on natural gas" and is overweight the oil sector, owns some junior gas names with exposure to liquids, but is choosey because some are no longer cheap.

His Sprott Energy Fund holds stocks like Delphi Energy, Crocotta Energy Inc. and Vero Energy. "Most people are viewing natural gas names as very poor economics, and [thinking] there can't possibly be an investment opportunity," he said. "That is a total fallacy."