Time for Natural-Gas Autos?

By MIKE HOGAN
Barron's Online
August 29, 2009

The investment outlook for natural gas gets brighter.

AS "CASH FOR CLUNKERS" DEMONSTRATED, AMERICANS love a deal. And Congress may have yet another for you when it returns from summer recess.

The plan is to offer tax credits worth up to $12,500 on the purchase of new cars and trucks. The catch is that your new vehicle must run on natural gas -- compressed natural gas, or CNG, to be precise. A Senate bill, the counterpart to the House's NAT GAS Act, also would offer up to $64,000 in tax credits on fleet vehicles, and up to $100,000 to anyone opening a CNG filling station.

Washington is beginning to wake up to the value of using this plentiful, homegrown fuel for transportation -- and that in turn could open up some intriguing investment opportunities.

Right now, only one CNG car -- Honda's Civic GX -- is available to U.S. buyers. But a dozen auto makers sell some two dozen CNG models overseas, and the Web can help you track their development. For an overview of the current cars, go to www.cngnow.com and click CNG Vehicles Around the World.

AOL Autos also is packed with good information (http://autos.aol.com/gallery/hybrid-cars-15k-25k). Likewise, CNG Chat (www.cngchat.com) lets natural-gas vehicle owners share operating tips and parts sources, and the Environmental Protection Agency offers a searchable database of hybrids (www.fueleconomy.gov/feg/byfueltype.htm).

[In Canada, the Canadian Natural Gas Vehicle Alliance represents those businesses involved in natural gas vehicles and who would like to see the use of gas expanded as a vehicle fuel. www.cngva.org. The CNGVA provides a list of only 22 natural gas fueling stations in British Columbia.]

NATURAL-GAS ENGINES -- found in some American buses and fleet vehicles -- have clear appeal. Boosters say a "gallon equivalent" of natural gas is about half the price of gasoline or diesel and produces about a third the harmful emissions. And America is swimming in the stuff.

Although a shortage of natural gas was forecast a couple years ago, supply has surged 50% since then -- primarily as a result of record gas discoveries in the strategically located Barnett, Haynesville, Marcellus and Bakken shale fields. These so-called unconventional sources are tapped using methods pioneered by outfits like Chesapeake Energy (ticker: CHK) and Denbury Resources (DNR) and can be quickly disseminated through the nearby pipelines of El Paso Corp. (EP) and Kinder Morgan Energy Partners (KMP).

Still, CNG vehicles in America face the same chicken-and-egg dilemma other hybrids do: building a refueling network. Refueling stations are scarce because only about 150,000 of America's 250 million automobiles are CNG-powered.

So near-term, it will be large commercial shippers like Wal-Mart (WMT) and PepsiCo (PEP) that drive increased use of natural gas on the road, predicts Andrew Littlefair, chief executive of natural-gas filling-station operator Clean Energy Fuels (CLNE).

Operators of America's long-haul trucks can afford natural-gas pumps in their shipping yards, and utilize Clean Energy's growing network of 184 North America truck stops. The economic incentives are fairly obvious for these big energy users, less so for consumers paying a premium for CNG vehicles.

ALL THIS ADDS UP TO AN INVESTING outlook that, while cloudy for the moment, seems likely to brighten.

Institutional investors see many good long-term values among the sector's 40 or so exploration-and-production and field-service companies, says Jon Najarian, co-founder of Chicago-based optionMONSTER (www.optionmonster.com). But depressed commodity prices and potentially punitive regulations directed at energy trades have kept many on the sidelines. Najarian is seeing lower-than-warranted volumes in the U.S. Natural Gas Fund (UNG), the main proxy for the volatile commodity, and other energy ETFs like the levered ProShares Ultra Oil & Gas (DIG) and its inverse, UltraShort Oil & Gas (DUG).

On the other hand, commodity volatility provides plenty of trading opportunities. Najarian recommends a covered-call strategy -- going long on a natural-gas stock or fund while selling a call on the same issue, to profit from both up and down price movements. OptionMONSTER's Covered Call Investor newsletter will walk you through this complicated swing-trading strategy for $149 monthly. At optionmonster.com, click Options Products, then Covered Call Investor.

Auto makers are another possible way to play the trend. But even a marked increase in CNG car sales won't provide much earnings catalyst for giants like Honda (HMC) and Toyota (TM), which plans to bring some of its CNG-powered vehicles here in the future.

Clean Energy is among potential winners. It just opened the world's largest natural-gas fueling facility at the Port of Los Angeles, and completed an $8.30-a-share offering that brought in $73 million. Shares recently closed at $12.78, bouncing off a 52-week low of $3.23 last November and a wider-than-expected second-quarter loss in August.

Likewise, Fuel Systems Solutions (FSYS), which supplies electronic gas-flow systems to car makers, picked up the technology for a home-refueling appliance when Honda liquidated its FuelMaker subsidiary in May. FSYS shares recently closed around $30 after the company handily beat second-quarter earnings estimates in a 52-week range of $10-to-$61. With a forward price/earnings ratio of 16, FSYS may appear fully priced, but not in view of a quarterly earnings-growth rate of 56% compared with the prior year.

THE QUESTION FOR ALL CNG-RELATED stock is: Will there be a legislative catalyst? Congress will have a lot on its plate when it returns to Washington -- bigger fish to fry, as it were. On the other hand, Senate Majority Leader Harry Reid of Nevada and White House Chief of Staff Rahm Emanuel head the bill's glittering list of supporters.

Among the politically influential fans cheering the Senate bill at the recent Clean Energy Summit were Bill Clinton, his former chief of staff John Podesta, Al Gore and BP Capital Management Chairman T. Boone Pickens. Populating American roads with CNG cars is Pickens' Plan B to cut our foreign-oil bill by a third. The renowned energy investor has pulled the plug (temporarily) on Pickens' Plan A: building the world's largest wind farm.

Sums up Najarian: "There are all kinds of reasons to be bearish on this sector in the short term -- and just as many reasons to be bullish in the long term."

E-mail: mike@mikhogan.com

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