Got gas?

The world has a lot more natural than anybody thought—if you count the unconventional supplies that once were out of reach to drillers. The world has 3,250 trillion cubic feet of unconventional natural gas resources, energy research company PFC Energy said on June 9. That’s way north of the world’s estimated 620 trillion cubic feet of conventional natural gas resources.

If the new estimates are accurate, and they’re not outlandish given that tapping unconventional natural gas resources in the United States has doubled domestic gas supplies to 8 trillion cubic feet from 2000 to 2008—who loses and who wins?

Losers:

• High-cost, high-leverage producers of natural gas. Natural gas was selling for just $3.75 per million BTUs (British Thermal Units) on July 16. That’s a huge 34% below the December price and an even  larger 75% below the high for this commodity cycle. Part of the problem is falling demand thanks to the recession. The U.S. Energy Information Agency has projected that U.S. natural gas demand will fall 2.2% in 2009. But soaring supplies have also depressed natural gas prices. And more supply from unconventional sources will make supply-side problems worse.

 Just at a time when producers such as Chesapeake Energy (CHK) are already struggling to pay off or roll over the huge debt they took on to develop these resources.

• Russian natural gas giant Gazprom (OGZPY). Eventually. Projections say that Europe has vast resources of natural gas from shale and coal-bed methane that, once developed, could lessen the European Union’s dependence on Russian natural gas.
• Liquified natural gas projects and the companies backing them. Turning natural gas into a liquid, shipping it across oceans, and then turning it back into a gas before putting it into conventional pipelines is a hugely expensive proposition. Spending the billions it takes to develop one of these plants makes sense only when natural gas prices are predictable and where long-term supply and demand projections for specific markets are reliable. That said don’t expect an end to the recent global boom in the construction of liquefied natural gas plants. The high-volume national producers of Qatar, Nigeria, and the rest of the pack can deliver natural gas to the Lake Charles, Louisiana hub for as little as 25 cents per million BTUs. Do expect, however, big cuts in the profits oil and natural gas companies projected when they sunk billions into these plants.

Winners

•  Low-cost, low-debt gas producers such as Ultra Petroleum (UPL) with a finding and development cost of about $1.10, according to Morningstar.com. Supplies of natural gas from unconventional sources—such as the natural gas rich shales of Texas and Arkansas—may be plentiful but they can also be expensive to develop and produce. For instance, to get natural gas to flow out of the dense rock of some unconventional reserves, producers have to fracture the rock with water under high pressure. Unconventional wells also often show very fast depletion rates—which means that even rich fields may be profitable only as long as the producing company continues to drill new wells.
• The pick and shovel companies that supply the technology to find and exploit these unconventional supplies of natural gas. When it comes to technology in the oil field, Schlumberger (SLB) is always a good bet but some smaller companies, including some natural gas producers, have led the way in developing the technologies needed to get natural gas out of these challenging geologies. I’d put Devon Energy (DVN) in that small group. In 2002 the company acquired Mitchell Energy and Development, the company that pioneered the technology that finally made unconventional production from Texas’ Barnett Shale economically feasible. That expertise makes the company, with about 90% of current production concentrated in North America, a partner in high-demand for international producers looking to get into the unconventional natural gas boom. Devon has recently formed a joint venture with France’s Total (TOT) to produce natural gas on 1.4 million acres in France.

I’m not rushing to buy much of anything in the energy sector right now: the rally to $70 a barrel oil went too far, too fast, and right now we’re seeing a correction of part of that run. (I’ll tell you about a couple of exc exceptions in the next week or two.) Oil closed at $63.02 on July 16.

But in the long term? I’ll definitely be looking to rebuild the energy position in my portfolios.

(Full disclosure: I own shares of Ultra Petroleum in my personal portfolio.)