Natural gas? Play the Rocky Mountain high

By Jim Jubak

What's the hottest energy play in the lower 48 states?

It's not Louisiana.

And it's not Texas.

Try the Rocky Mountains.

The fastest-growing supply of onshore natural gas in the lower 48 states comes from the Rocky Mountains. Proved reserves of natural gas in the region have tripled since 1977, according to industry consultant Wood Mackenzie. The three key Rocky Mountain basins -- the Green River Basin in Wyoming, the Uinta-Piceance Basin in Utah and the Powder River Basin in Wyoming -- will see natural-gas production climb by 22%, 56% and 10%, respectively, from 2007 through 2011.

Bet you'd like to own some stock in the companies with the biggest stakes in that region. But you're afraid they're too pricey. Have I got a buying opportunity for you. Thanks to a lack of pipeline capacity in the region, natural-gas companies are going to have to rein in growth in the second half of 2007 and into 2008. A local glut of natural gas has already driven the price of Rocky Mountain natural gas to a deep discount versus the commonly quoted Henry Hub benchmark price.

Know what that means? The best producers in the fastest-growing production area in the lower United States are going to turn in comparatively lousy earnings growth over the next quarter or two. And that will be your chance to swoop -- in September or October or so -- and pick up these stocks before new pipeline segments set to open in 2008 and 2009 start to eliminate the glut and wipe out much of that discount in regional natural-gas prices.

Rock solid

I'm going to start with the big picture and then zoom in on three stocks that have the most potential to profit from continued growth in natural-gas production from the Rocky Mountains.

First, a quick geology lesson. The Rocky Mountain natural-gas reserves are the result of a huge sea that stretched from Louisiana into Canada and that divided North America in half for 25 million years. For year after year, plants and tiny sea animals lived and died in this ocean, building up huge deposits of organic material that under pressure turned into natural gas and bitumen (a kind of very heavy oil). As the region folded, eroded and refolded, those deposits wound up buried in rock layers resting at oftentimes crazy angles. Much of those reserves existed as smaller pools of oil, or as oil and natural gas "trapped" in finely grained sedimentary rock.

Getting the natural gas out is extremely difficult because of that geology. Getting oil out is even harder -- so tough that no one has yet really solved the problem.

On the natural-gas side, Mitchell Energy drilled the first discovery well for natural gas in the Barnett shale formations of Texas and Oklahoma in 1982. Over the next decade, natural-gas companies developed new drilling technologies and new methods for fracturing the shale formations so the natural gas could escape from the rock. Flow rates gradually climbed; horizontal wells in the Barnett region now produce 2.1 million to 3.5 million cubic feet of gas a day. Higher flow rates meant that wells became more profitable more quickly. That sent natural gas companies searching over a wider region that now stretches from the Barnett wells of Texas into the Canadian Rockies.

What's called "unconventional" natural gas -- gas from tight sands, gas shale and coal-bed methane -- now accounts for about 30% of all gas produced in the United States. And this production couldn't be arriving at a better time, since production of conventional natural gas has peaked in the United States. (This isn't coincidence: It's the higher prices for natural gas that come from a production peak that have made it profitable to develop unconventional sources of natural gas.)

Oil and water

The story on the oil side isn't nearly as positive. While it's possible to release natural gas from these formations by fracturing the rock underground by injecting nitrogen or other gases or sand into the formation, you have to cook the rock to get the oil out. ExxonMobil (XOM, news, msgs) spent $5 billion on its Colony Oil Shale Plant in Colorado in the aftermath of the Arab oil boycott in the 1970s before pulling the plug. That plant mined the rock and then cooked it above ground to release the oil. The current round of research plants try to cook the oil underground by injecting steam or inserting giant electrodes into the ground.

Continued: Questions remain

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