Waiting for Gas to Heat Back Up

• ByTim Melvin, RealMoney.com Contributor
• On 12:00 pm EDT, Friday September 11, 2009

There has been a lot of talk lately about the price of natural gas. The stuff just keeps going down on over supply and weak demand as a result of the recession. I am not a commodity trader or energy expert, so I cannot give you any meaningful insight into the hows and whys of the market place.

I do know a little about stocks and the economy, however, so I will say that there is absolutely no way the price of natural gas stays this low for a long period of time. The stocks of companies that explore and produce natural gas, as well as the drilling services companies who support them are getting very cheap and are approaching bargain territory.

Something else I am pretty sure of is that eventually the talk of greener energy is going to have to turn in the direction of natural gas. All the attention now is on wind, solar and cleaner coal technology for political reasons. The reality is that natural gas is a cleaner fuel than conventional oil and gasoline products and the one fuel we have a plentiful supply of right now. At some point we will start to have serious discussions of more natural gas usage and fully expect to see more natural gas vehicles on the roads in the years ahead. It just makes sense.

One of the obvious picks in the sector is a company that Jim Cramer has talked about recently: XTO Energy. The company does a lot of what is considered unconventional exploration and production and has sizable shale and coal bed methane properties and reserves.

XTO has a history of growing through acquisitions and with gas at these price levels it should get some decent opportunities to add reserves very cheaply. I would love to see the stock come back towards the tangible book value. If it did, I would be an aggressive buyer.

Pioneer Natural Resources is another potential gas rebound play. The exploration and production company currently has about 52% of its reserves in natural gas and the rest is oil; 97% of operations are based in North America, but it does have small positions in fields in Africa.

The stock is trading a few points above tangible book value and I would wait for a pullback towards that level before accumulating. As it nears that price, I would probably try to back into the stock by selling one- and two-month puts.

The drilling companies should benefit from rising natural gas demand and prices in the years ahead as well. I have owned Rowan for quite some time and written about it on several occasions. The stock is well off the lows but still trades below tangible book value, so it can be nibbled at these levels.

I have also owned Bronco Drilling for some time with less-than-spectacular results so far. The stock trades at just 30% of book value and about 23% of the takeover offer that was made in 2007. It is far more speculative than Rowan, but the potential reward is enormous when demand returns to the land-based drilling market.

Natural gas utilities are another area that is starting to make sense. As the lower price and adequate supply of gas along with its clean air benefits attract more demand in the future, they will be the suppliers.

Right now the only company I can find selling at or below tangible book value is Southwest Gas. This company has been hit by reduced demand as it serves three of the hardest hit states in the recession and real estate collapse. Southwest is the largest natural gas distributor in both Nevada and Arizona and also have operation in California.

The company has negotiated much of the .turbulent time successfully. Although subscriber growth has slowed, the balance sheet did improve to the point that Standard & Poor's raised its rating a notch earlier this year to BB from BBB.

The company also has a distribution construction subsidiary: Northern Pipeline. The division constructs town border station to the end-user distribution systems and also does maintenance work on the systems. I would stay small and move slow accumulating this stock as there is now way to know when situation in its major markets will begin to improve, but I like the long-term prospects for the company.

I have no idea when natural gas will begin to recover. I do not like buying things that are at new lows and gas certainly qualifies. I am not an expert but I plan to spend some time talking to friends and associates in the near future to discover more ways to play the long-term recovery of this market.

Buzz up!