2 Powerful Plays on Natural Gas

Mark Hanson: Since 2007, natural gas production in the United States has grown by 40%, thanks to the development of low-cost regions like the Marcellus and Utica shales in the northeastern part of the country, as well as activity in areas like Texas and North Dakota, where natural gas comes out of the ground as a byproduct of oil production (this is called "associated gas").

Our long-term forecast for the price of U.S. natural gas is $3 per thousand cubic feet (mcf), which is modestly above the current price of this commodity. Our $3 long-term price estimate is based on three factors. First, given the productive capacity of the Marcellus and Utica shales, these two regions should be able to meet almost all incremental gas demand in the U.S. through 2020, once associated gas is factored in. Accordingly, we view the Marcellus and Utica as the price-setting regions in the U.S. supply stack, with break-even levels around $3 per mcf. Second, underlying natural declines across oil-rich areas continue to slow, which means associated gas volumes are likely to be more robust than many expect. Third, prices for drilling and completion services--the primary costs incurred by producers--are likely to remain under pressure, as producers won't require as many drilling rigs or fracturing jobs to maintain supply. This should also serve to keep natural gas prices in check.

While the Utica and Marcellus will likely set a natural cap on U.S. natural gas prices over the next several years, a combination of record power generation demand and Northeast infrastructure constraints could set the stage for a natural gas rally above the futures curve over the next several quarters.

Although under a long-term price assumption of $3 per mcf, there aren't currently many compelling opportunities for equity investors. Pipeline companies do offer a handful of opportunities, however, with Enterprise Products Partners (ticker EPD) and Spectra Energy Partners (ticker SEP) both trading at 4-star, or buy-rated, levels.