While everyone is watching to see how low oil prices will affect U.S. shale drillers, natural gas production continues to rise. Each month, the U.S. posts new production highs (see chart), and 2014 is shaping up to be a record year for natural gas drillers. With production ratcheting upwards, the U.S. has been able to achieve record levels of storage injections, building back inventories after last winter walloped the east coast and depleted supplies.
The abundance of natural gas is allowing utilities to increasingly burn the fuel in power plants for electricity - a well-known trend that continues to accelerate.
But another sector also stands to benefit - the transportation sector. In particular, natural gas is likely to become a serious option for transportation fuels, particularly as an alternative to diesel in long haul trucking or in shorter fleet operations. It can either come in the form of compressed natural gas (CNG) or liquefied natural gas (LNG).
There are several advantages that natural gas has over traditional diesel or gasoline powered vehicles First natural gas can be a lot cheaper on an energy equivalent basis, generally a little more than $2 per gallon. There was certainly a much bigger disparity in prices earlier this year when gasoline prices cost more than $4 per gallon, but there is still a financial gain to be had (see chart below from U.S. Department of Energy). Moreover, crude oil prices won't stay this low forever, so natural…
While everyone is watching to see how low oil prices will affect U.S. shale drillers, natural gas production continues to rise. Each month, the U.S. posts new production highs (see chart), and 2014 is shaping up to be a record year for natural gas drillers. With production ratcheting upwards, the U.S. has been able to achieve record levels of storage injections, building back inventories after last winter walloped the east coast and depleted supplies.
The abundance of natural gas is allowing utilities to increasingly burn the fuel in power plants for electricity - a well-known trend that continues to accelerate.
But another sector also stands to benefit - the transportation sector. In particular, natural gas is likely to become a serious option for transportation fuels, particularly as an alternative to diesel in long haul trucking or in shorter fleet operations. It can either come in the form of compressed natural gas (CNG) or liquefied natural gas (LNG).
There are several advantages that natural gas has over traditional diesel or gasoline powered vehicles First natural gas can be a lot cheaper on an energy equivalent basis, generally a little more than $2 per gallon. There was certainly a much bigger disparity in prices earlier this year when gasoline prices cost more than $4 per gallon, but there is still a financial gain to be had (see chart below from U.S. Department of Energy). Moreover, crude oil prices won't stay this low forever, so natural gas should compete favorably on price over the long-term.
Second, natural gas prices, while historically volatile, have become a bit more predictable since the shale gas revolution took hold. Natural gas prices are expected to remain relatively stable for years to come, while oil prices are gyrating all over the place.
And for fleet managers - long haul trucking companies, municipal bus fleets, postal delivery - natural gas vehicles can act as a hedge against oil. With some of their vehicles using natural gas and others diesel, companies can diversify their risk.
But we have been hearing about the coming natural gas vehicle tidal wave for years, but it has yet to really take off. Why the slow start? There are some obstacles. First, natural gas vehicles cost more upfront. A new diesel long haul truck can cost $150,000, but for a CNG truck the price tag can be as high as $200,000. The CNG trucks end up paying for themselves, but the payback period averages four years. That is a problem when some fleets turn over their vehicles in four years or less.
Second, sometimes truck companies merely pass on the cost of fuel to their customers. That gives them less of an incentive to invest in more efficient natural gas trucks.
But one of the biggest problems is the dearth of infrastructure. There are only around 1,400 refueling stations, both public and private, for CNG vehicles. That pales in comparison to over 121,000 traditional gas stations across the United States. Companies are less likely to buy natural gas vehicles without adequate refueling infrastructure, and developers are not going to build more refueling stations unless they are sure there is a market - a classic chicken and egg problem.
Nevertheless, the market continues to grow briskly, if slower than the industry had originally hoped. For 2014, an estimated 11,000 long haul natural gas trucks will be sold, a 27% jump from a year earlier.
Ryder Systems Inc. (NYSE: R), a major commercial fleet supplier, is one of the stocks to watch. It announced on November 12 that it forged a strategic alliance with Mansfield Clean Energy Partners, a joint venture between Mansfield Energy Corp. and Clean Energy Fuels Corporation (NYSE: CLNE), a builder of CNG refueling stations. The alliance will offer potential buyers the option of natural gas vehicle leasing from Ryder and fuel supply management from Mansfield.
The market trends look good. The average age of US Fleet Class 8 trucks was 6.5 years, just a bit below the record high of 6.7 years in 2011. By way of comparison, in the late 1990s, the average age of the commercial fleet across the country was just 5.3 years. This suggests that corporate fleets are aging and ready for major turnover - an enormous growth opportunity for companies like Ryder. Fleet replacement in 2013 sparked the fastest growth in heavy-duty truck manufacturing since 2006, up 21%. A further 17% expansion is expected this year. By 2015, the average age is expected to come down to just 6 years.
Ryder won its first natural gas vehicle order in Canada in October, with Canadian trucking company C.A.T. leasing 100 CNG vehicles. That is almost one-third if C.A.T.'s fleet.
Ryder also offers lease options for its fleets, and it argues that due to the complexity of tighter environmental and safety regulations, it will become more commonplace for shippers to outsource their trucking operations to companies like Ryder. Ryder has seen its earnings per share rise each of the last five years. Its share price is up nearly 50% year to date.
Westport Innovations Inc. (TSE: WPT) and Cummins Inc. (NYSE: CMI) are two other market leaders in the space. The two formed a joint venture, Cummins Westport, that makes 6 and 12-litre natural gas engines. These are smaller versions used in daily operations, such as municipal waste or bus fleets, rather than long haul trucking. They scrapped a 15-liter engine due to weak market conditions, but they are still bullish on the sector.
Westport in particular looks like an exciting company. It has 423 patents related to natural gas engines, the most in the market and more than even major car manufacturers like Ford (181) or Toyota (127) are holding. Westport's sales are projected to grow 15% annually for the next few years. It has struggled a bit in 2014, but by the end of 2015, it expects adjusted EBITDA to turn positive.
Clean Air Power (LON: CAP), a small UK-based company (market cap: $5.27 million) is working on a dual fuel system that allows long haul trucks to run on a combination of diesel and natural gas. It is an after-market product, essentially an upgrade kit to a heavy-duty truck that does not change the diesel engine that is already in place. Importantly, the system would allow drivers the flexibility to switch between fuels. UPS (NYSE: UPS) piloted 10 of Clean Air Power's dual-fuel trucks, and the 10 trucks have been integrated into UPS' operations.
Clean Air Power's share price has had a rough ride over the last year. The European market, on which the company focused, is not growing as quickly as anticipated. The company is in the midst of expanding into more lucrative markets like the U.S. and Asia, but it is still gearing up. Crucially, the company had a hiccup getting EPA certification, and its share price plummeted following the news in September. Yet, if the company can sort out the kinks, it offers a promising product.
In the short-term, the share prices of many natural gas vehicle makers will likely fluctuate with the price of oil. Although long haul trucking and natural gas vehicles still offer economic advantages over diesel even when crude oil prices are low, investors tend to pull away. But oil prices will not stay low forever - cutbacks in drilling will ensue and the subsequent contraction in supply will send prices upwards.
Additionally, tighter regulatory conditions on diesel engines are increasing costs for maintenance, which works in favor of natural gas vehicles.
Meanwhile, in China, growth is continuing at a much quicker pace. Although the phenomenon is more recent, China added more than 30,000 natural gas trucks to its roads last year. That trend is expected to accelerate as China leans more heavily on natural gas to clean up its air.
Over the long haul (pun intended), natural gas vehicles, while growing from a small base, are expected to capture an increasingly large slice of the transportation market.