How do you make money out of the current U.S. and global natural gas boom?

It's harder than it looks since the explosion in U.S. natural gas production -- a 21.6% increase from 2002 to 2011 -- has helped crush natural gas prices in the United States. Natural gas futures in New York closed on Wednesday at $2.52 per million BTUs. That's down from $10.36 in June 2008, a 75% decline.

With the break-even cost of producing natural gas in the United States somewhere between $4 and $8 per million BTUs, you can see how this might not be the most profitable time to be a natural gas producer. Shares of Chesapeake Energy (CHK), for example, were down 31% for the 12 months that ended on June 20.

But I think three recent news items give investors the skeleton of a strategy for profiting from what is a global boom in natural gas. I'll finish by putting some flesh on that skeleton with three stock picks in the sector.

The latest on gas

The first news story: On June 18, Exxon Mobil (XOM) announced that it was shutting down its efforts to find natural gas in Poland's shale formations.

This isn't the first bad news natural gas exploration companies have received in Poland recently. On early estimates, Poland looked as if it might provide a replay of the shale story in the United States -- the U.S. Energy Information Administration had estimated that Poland might have 5.3 trillion cubic meters of natural gas locked up in its shale geology. That would have given the country the largest gas reserves in Europe.

But more recent estimates by geologists working for the Polish government have trimmed those estimates to 350 billion to 770 billion cubic meters. That's still a lot of natural gas for a country that currently imports two-thirds of its 14 billion cubic meters of annual consumption.

Image: Jim Jubak

Jim Jubak

But the Exxon Mobil pullout was actually more puzzling than simply more bad news. The company had drilled just two test wells before deciding to pull up stakes.

The suspicion among other exploration companies in Poland is that Exxon Mobil's decision had less to do with two dry wells in Poland than with its deal last week to develop shale oil reserves in Siberia with Rosneft, Russia's oil company.

My conclusion: I think Exxon Mobil bailed on Poland for two reasons. The first is time. The time needed to develop natural gas volumes in Poland is just too long, especially if you include the need to build infrastructure. The Polish government projects that the country could see its first commercial gas production in 2014-2015 at a very modest 0.5 billion to 1 billion cubic meters. And that only gets the gas out of the ground. Then there's the time and expense of developing the infrastructure to get the gas to Polish consumers and, potentially, to consumers outside Poland. The more time, the more risk. Although no one is sure how long it will be before large volumes of cheap liquefied natural gas will be available to Poland, current plans point to 2015 to 2018, with 2018 being more likely, in my opinion. Second, the economics of natural gas continues to decay. Exxon Mobil's preference for investing in Russian oil shale instead of Polish gas shale makes perfect sense if you consider that no one is certain where the bottom might be for natural gas prices -- or how long the current premium price for gas delivered in Europe or Asia might last.

The second news story, and it fits right in with where I've left Poland and Exxon Mobil: The U.S. Department of Energy estimates that production of natural gas liquids hit an all-time high in March and is now 50% above 2009 production. That has driven the price of some natural gas liquids down by 60% in the past year. Ethane, for example, now sells for just 8 cents a pound, and some market analysts think that producers could wind up simply giving away ethane later this summer. That is really bad news for natural gas producers -- particularly U.S. producers -- because they've been counting on sales of liquids such as ethane, propane and butane, which can be stripped out of the natural gas stream, to make up for plunging prices of natural gas itself. This has the effect of cutting cash flow at natural gas producers, and that's not good news for exploration and production. It adds yet another layer of uncertainty for natural gas producers.

My conclusion: With the economics of natural gas under pressure from this new direction, it's no wonder that a producer such as Exxon Mobil might decide to go with oil over natural gas. In addition, this new wrinkle undercuts the premium that investors have been willing to pay for the shares of natural gas producers with big positions in liquid-rich geologies in the United States. In other words, this isn't good news for companies such as Pioneer Natural Resources (PXD) or Concho Resources (CXO). Or for oil-services companies with exposure to U.S. exploration and development such as Halliburton (HAL) and, to a lesser extent, Schlumberger (SLB). It is good news for chemical companies, such as Dow Chemical (DOW), DuPont (DD) and LyondellBasell Industries (LYB) that use natural gas liquids such as ethane and butane for feedstock.

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The third news story: Norwegian oil and gas producer Statoil (STO) has signed an agreement with Malaysia's state-owned energy company, Petronas, to deliver liquefied natural gas to a terminal in Malacca. Malaysia's first liquefied natural gas terminal is set to open this summer, with the first Statoil delivery due in August. (Statoil also opened its first liquefied natural gas trading station in Singapore on June 1.) Malaysia has traditionally been a major exporter of natural gas to Japan, South Korea and Taiwan, but with domestic demand rising and supplies failing to keep pace, the country sees itself becoming a net importer over the long term.

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