Energy's Next Move

	Roger Conrad Utility Forecaster.com
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While Wall Street has focused on oil, natural gas prices are rising again. Here's how to play their move.

Few forecasted oil would break $50 per barrel. But with soaring global demand and rising turbulence in producing countries, further strength in oil even from these levels is highly likely in coming months.

Yet black gold's spectacular move has overshadowed an almost equally dramatic rally this year in the price of its primary substitute, natural gas. Gas has reversed its downtrend and, with the cold months coming on, is starting to surge.

Remarkably, gas remains undervalued relative to oil. For example, with oil trading over $54 per barrel, gas should sell for over $9 per million btu (MM/BTU), using the standard 5.8 MM/BTU per barrel conversion factor.

One reason gas has trailed is the lower terror premium, since most gas consumed in North America is also produced here. That's changing rapidly, however, as declining US and Canadian reserves have led to demand for imported liquid natural gas (LNG).

The International Energy Agency projects the LNG share of the North American gas market will rise from 1 percent in 2000 to 26 percent by 2030. That's a 68-fold increase in volume, much of which will come from the same, shaky group of countries now producing much of the world's oil. The result should be a rising terror premium for gas.

Two other reasons gas is likely to rise long-term: Capital spending remains sluggish due to fears of another price collapse, so efforts have focused on finding and developing very low-cost reserves.

Second, the 100 gigawatts of natural gas-fired power plants built in the US during the late 1990s and early ‘00s are going to increasingly displace much of the old coal and hydro plants as those wear out in the next 10 years. That means more gas use.

Even the most aggressive stocks, however, aren't factoring in anything close to today's energy prices in their long-term plans. That limits downside while keeping them in the game for big-time returns if energy prices don't take a break in coming weeks.

Get Liquid

This month, Income Portfolio pick BP inked a deal to supply Sempra Energy with about 3.7 million tons of LNG a year for the next two decades. The LNG will come from BP's Tangguh field in the Papua province of Indonesia, and will be processed through terminals Sempra is constructing in North America. Gas will be sold into energy-starved California.

The deal is relatively small potatoes for both companies. Super oil BP's biggest venture at this point is in Russia, where it's enjoying far better than expected boosts in oil output. As Southern California's monopoly power and gas company, Sempra's major non-utility operations are a highly profitable energy marketing and power production unit, with some related infrastructure.

However LNG—at an anticipated cost of $2.50 to $3.25 MM/BTU—is expected to be highly profitable for both companies. BP, for example, has also signed on major companies in China and Korea as LNG customers, including dominant steelmaker Posco.

Sempra is building LNG terminals in the US, capable of taking the stuff and processing it into shippable natural gas. Terminals are in development in Louisiana and Baja California and the company plans to have at least three total up and running by 2007.

On the other side of the country, Income portfolio denizen Dominion Resources has purchased and restarted the Cove Point LNG terminal on the coast of Maryland. With gas demand rising rapidly, Cove Point is expected to be a major profit center for the company in coming years.

Dominion, a major producer of gas in the Gulf of Mexico and Appalachia with 6.4 trillion cubic feet of reserves, runs a 7,900 mile gas pipeline and storage system to service the Middle Atlantic region, serves 5 million retail power and gas customers in nine states and runs 25 gigawatts of power plants.

Like Sempra's, Dominion's business mix should allow it to profit solely from the country's increased demand for gas. Even if gas prices should head lower in the short run, both should hold their ground (and dividends). And both are cheaply priced even at the lowest available estimates for 2005 earnings. Buy Dominion up to 68, Sempra to 40.

As for BP, downside on a dip in gas and oil is likely the low to mid 50s. Intermediate-term upside from just 12 times best case 2005 earnings is the mid-70s at least. Despite BP's recent surge, there are few better ways to bet on oil, gas and the growth of LNG. Patient, long-term investors without a position can still buy BP up to our new target of 60.

Pipeline Picks

As Income pick TEPPCO Partners' pipeline and related assets are a low-risk way to play continued demand for oil, Enterprise Products Partners is a high potential way to bet on strong future gas use.

Forged from last month's merger between Enterprise and GulfTerra Partners, the new LP transports gas, LNG and oil through 31,000 miles of on and offshore pipelines and related assets. Services include transportation, storage, fractionation (the process of separating raw fuel into derivative products) and offshore production services, among other things.

The merger is aggressive and there are soft points, notably the former GulfTerra's low credit rating and some economically sensitive business lines run by the former Enterprise. But there's also a potential $140 million in annual savings and numerous growth opportunities for the combination, which is now the nation's second largest pipeline partnership enterprise.

That means plenty of room to run for the already generous dividend. Enterprise is a buy up to 23. TEPPCO remains a buy on dips to 40.

ONEOK's base is a very steady regulated natural gas utility business serving nearly 2 million customers in Kansas, Oklahoma and Texas, coupled with 5,600 miles of pipeline and related assets in that region. It further expanded that core this summer by acquiring the general partner interest in Northern Border Partners, owner of a critical stretch of interstate pipeline connecting Canadian gas with Midwest demand.

With those divisions earning steady results year-in, year-out, ONEOK has been able to deploy cash to build a high-growth natural gas production unit, a portfolio of gathering assets and profitable trading operations. The result: An energy powerhouse capable of growing earnings 10 percent or more a year, even if gas and oil plateau, paying a solid yield of nearly 4 percent and trading at just 13.2 times the lowest estimate of profits for 2005.

The greatest risk is likely from regulators, particularly in the historically tough climates of Kansas and Oklahoma. Relations, however, seem solid for the moment and the credit rating of A-(stable) from S&P gives the company a sizeable cushion should energy prices dip. Buy ONEOK up to 28.

High-Yield Energy

Canadian royalty trust PrimeWest is by far the riskiest pick on our list. Like the three Growth Portfolio oil and gas trusts, cash flow and dividends are highly dependent on oil and gas prices staying high and the units can be volatile.

PrimeWest's recent acquisition of the general partner interest in the Canadian gas reserves of cash-strapped Calpine, however, should insulate it from the worst of gas market ups and downs. Even if its yield were trimmed a bit from its recently increased level of C$0.30 per month (C$3.60 a year, or about 23.6 cents US per month), the trust's yield would still be blockbuster.

Held as Calpine Natural Gas Trust, the Calpine assets are among the more potentially lucrative in Canada. They should boost PrimeWest's results by adding production as well as cutting costs and providing new opportunities for drilling—by far the lowest cost way to acquire new reserves and production with energy prices at these high levels.

The primary risk is falling oil and natural gas prices would almost surely hit the stock as it would other trusts. For more aggressive investors, PrimeWest is a buy up to 23.

Roger Conrad will be available to take your questions until Monday, November 1. Please use the form below to submit your questions.