How To Invest In Natural Gas

Natural gas has made headline news over the last year, with prices soaring to a 15-year high after Russia’s invasion of Ukraine, while spiralling energy bills triggered a cost-of-living crisis in the UK.

But the energy crisis had a silver lining for some investors, with oil and gas giants BP and Shell reporting bumper profits on the back of natural gas prices increasing seven-fold in just over two years.

Although natural gas is often lumped together with oil and coal, it’s a lower-cost and cleaner source of energy in terms of emissions. As a result, natural gas is expected to play a key role in the transition to net-zero emissions.

We’re going to take a look at some of the benefits and risks of investing in natural gas, together with the wider outlook for the sector.

Investing is speculative and your capital is at risk. It is possible to lose some or all of your money.

Why is natural gas important?

Natural gas is one of the most popular sources of energy for heating and power generation, additionally providing fuel for transportation, air conditioning and industrial processes.

In the UK, domestic households are the largest consumers of natural gas (for cooking and heating), followed by electricity generation, according to the latest Energy in Brief report by the government.

And it’s a similar picture globally, with natural gas accounting for around a quarter of fuel used by domestic households, second only to oil.

How is natural gas priced?

As with other commodities, the price of natural gas is driven by supply and demand. On the demand side, factors include the price of alternative fuels, level of stored reserves and seasonal temperatures. On the other side of the equation, extreme weather events, mechanical breakdowns and geopolitical factors can affect supply.

Looking at demand, the US is by far the largest consumer of natural gas, followed by Russia and China. The largest gas-producing country is also the US, then Russia, with a significant drop in volume for the third-highest producer, Iran.

The industry benchmark for natural gas is the Henry Hub Natural Gas futures, traded on the Chicago Mercantile Exchange.

Figure 1 shows how the average natural gas price has changed over the last five years, with the price rising from around $3 per million British thermal units (Btu) in 2018 to a high of almost $9 in late 2022.

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Figure 1: the average Henry Hub natural gas spot price from 2018 to 2023Source: U.S. Energy Information Administration (EIA)

While oil prices plummeted in the early stages of the pandemic, natural gas prices remained relatively steady. The main reason was strong residential demand for energy, offsetting the fall in demand for transportation and manufacturing.

However, gas prices soared in 2022 before falling back to more normal levels.

Garry White, chief investment commentator at Charles Stanley, explains: “The price of natural gas spiked following Russia’s invasion but helped by swift action to find alternative supplies and a mild winter, prices are now back to a level seen before Moscow’s act of aggression.”

Why invest in natural gas?

Natural gas remains one of the most-used fossil fuels globally and, despite the shift to renewable energy, it is likely to remain a significant part of the energy mix for some time.

Mr White comments: “Environmentally, it is cleaner than coal and oil in energy generation – so it is regarded as a ‘bridge’ fuel in the clean-energy transition.”

He also expects supply constraints to continue, in the medium term at least, due to the EU’s commitment to phase out gas imports from Russia.

Investors looking for exposure to the energy sector may also be attracted by the lower-risk option of natural gas companies compared to some of the more speculative energy companies focusing solely on renewables.

Alex Campbell, head of communications at Freetrade, comments: “Rather than backing some of these high-flying green energy companies that are still yet to ship a tried-and-tested product, companies in the natural gas supply sector tend to target efficient and hopefully predictable capital returns to shareholders through buybacks and dividends.”

Investing in natural gas also provides an opportunity for investors to diversify their portfolio into commodities and may offer a potential hedge against inflation. In addition, natural gas is the third-most traded commodity globally due to its price volatility.

What are the drawbacks of investing in natural gas?

Over the long-term, global demand for natural gas is expected to decline with the transition to renewable energy. The IEA forecasts an increase in demand of 5% in the current decade, significantly below the 20% growth in the last decade.

Another potential drawback is the level of risk caused by the volatility of natural gas prices, as with other commodities.

Charles Stanley’s Garry White comments: “Volatility in natural gas demand often leads to big spikes and declines in its price. The risk involved in derivatives trading can even result in professional investors losing a substantial amount of money.”

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Hedging – an investment strategy to protect against a potential adverse movement in the price of an asset – may also reduce the potential profit for gas-producing companies when prices rise.

Freetrade’s Mr Campbell comments: “Producers will manage their exposure to the spot price of the commodity through hedging strategies. Properly-executed hedging should manage downside risks when prices fall, but it also means that there is less upside in revenues when prices rise.”

What are the options for investing in natural gas?

There are a range of options for investors looking to add natural gas exposure to their portfolios, from investing in individual companies to broader-based commodity funds.

1. Investing in natural gas companies

UK energy giant Shell (SHEL) is one of the world’s largest natural gas producers, as well as a leading producer of liquified natural gas (LNG). LNG is seen as a growth sector due to its ability to be exported by sea, with rising demand from both Asia and the Europe.

Mr White comments: “It was announced last year that Qatar, which has some of the biggest natural gas reserves in the world, was planning on bringing Shell on as a partner for the second phase of its LNG expansion.”

Shell may also appeal to investors looking for income as well as capital growth.

Mr Campbell comments: “While Shell has seen its share price run up 28% in the last 12 months, an attractive 3.79% dividend yield, and plans to continue to repurchase shares should still provide investors with attractive returns.”

EQT Corporation (EQT) is a mid-cap natural gas producer, headquartered in the US and listed on Nasdaq. It’s one of the largest producers and exporters of natural gas in the US.

Freetrade’s Mr Campbell comments: “This pure-play natural gas producer is focused on returning cash to shareholders in the coming years through buybacks and dividends. With demand rising in 2022, EQT has seen its share price rally about 48%.

“While there are lingering environmental concerns about methane leaks in the Appalachian basin, EQT is also aiming to be one of the first natural gas producers to reach net zero by or before 2025.”

Cheniere Energy (LNG) is also one of the largest US producers of natural gas and is listed on the New York Stock Exchange.

Shareholders have been rewarded with a tripling in the company’s share price over the last five years, although it is currently trading on a relatively modest dividend yield of 1%.

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Charles Stanley’s Mr White comments: “Cheniere has announced plans for a major expansion at its flagship terminal on the Louisiana coast, aiming to capitalise on surging overseas energy demand.”

2. Investing in natural gas funds

Investors have the option of funds tracking commodity prices or broader funds that invest in natural gas companies (rather than the commodity itself).

In terms of pure commodity funds, the United States 12 Month Natural Gas ETF (UNL) tracks the price of Henry Hub natural gas and has delivered a three-year total return of 87%, according to Trustnet.

Alternatively, the broader-based First Trust Nasdaq Oil & Gas ETF (FTXN) tracks both oil and gas prices and has rewarded investors with a three-year total return of 143%.

Looking at funds investing in natural gas companies, the iShares Oil & Gas Exploration & Production ETF (SPOG) invests in global oil and gas producers, with a three-year total return of 116%.

Although the iShares S&P 500 Energy Sector UCITS ETF (IESU) focuses on oil and gas companies, it invests across the whole energy sector which might appeal to investors wanting exposure to renewables. It has achieved a three-year total return of 131%.

What is the outlook for investing in natural gas?

Looking ahead to the next year, natural gas prices are expected to remain at or around their current levels.

Charles Stanley’s Mr White comments: “A price spike back up to levels seen in the middle of last year seems unlikely. The energy crisis caused by the Ukraine war damaged confidence in its reliability as a transition fuel.”

The IEA also recently downgraded their forecast for natural gas prices, stating: “One of the effects of Russia’s actions is that the era of rapid growth in natural gas demand draws to a close.”

In the longer term, natural gas is likely to be phased out by many countries as part of the transition to net-zero emissions. The UK is banning the sale of gas boilers from 2035 and has pledged to ramp up electricity generation from renewable energy rather than natural gas.

However, rising demand from emerging economies such as China, India and Russia is expected to offset at least some of the fall in demand from the US and Europe.

As a result of these potential risks, investing in natural gas should only form a small part of a diversified investment portfolio.