Citi equity strategist Kingsmill Bond and his team are out with a lengthy report on the natural gas revolution and some of the biggest trade opportunities he thinks it will present.
Bond's advice is to "follow the pig through the python." The report begins, "The gas revolution (the pig) is expanding through the world (the python), impacting a series of sectors and countries, from coal to chemicals, shipping to automotive."
The biggest investment opportunity here, according to Citi: "gas on oil arbitrage."
Bond calls the trade "one of the great arbitrage opportunities in the world at present," symbolized in the chart below, although he says it's the hardest within the energy sector to capture.
In the report, Bond writes:
The difference between the gas price in [North America] and the oil price is the largest of any of the arbitrage opportunities, but of course the hardest one to arbitrage. However, we believe that arbitrage opportunities of this size are usually exploited, especially in a market which like the US is both large and open, and that the coming years will see a determined attempt to replace oil with gas in the transport sector.
Companies like Clean Energy Fuels in the US are leading the drive to shift to gas, and, as argued in more detail in our companion piece, we believe that up to 30% of the US heavy truck fleet could be converted to gas by 2020.
A companion piece by Citi commodities strategists and economists led by Anthony Yuen and including Edward Morse takes a deeper dive into the economics behind the gas on oil trade.
The main points of that piece are summarized below:
- Increasing demand for natural gas will drive the arbitrage opportunity more than developments on the supply side. Citi points out that "Shell, FedEx, UPS and Waste Management have all announced measures to shift large parts or all of their heavy truck fleets to CNG and/or LNG."
- Up to 30 percent of the U.S. heavy truck fleet could switch from diesel fuel to natural gas by 2020. Citi cites fuel economy mandates, in addition to price differentials between the fuels, as a key driver of the shift. Furthermore, they note that both Shell and Clean Energy Fuels have announced plans for developing natural gas filling station infrastructure in the United States.
- China is starting to undergo the same shift. The Citi report says that "central and local governments encouraging the use of [natural gas] for trucks in their gas producing regions in Xinjiang and areas around the Yangtze River Delta, which includes some significant population centers such as Shanghai."
- Bunker fuel (fuel for marine shipping vessels) is another area expected to make the shift to natural gas in the coming years. Citi says that the first company to do so – Saudi Basic Industries Corp – just placed orders for newly-equipped vessels this quarter, and EU regulations that mandate sulfur reductions in marine fuel and take effect at the beginning of 2015 will be another driver of this shift.
Eventually, the report says the substitution to natural gas could also make its way to the petrochemicals industry, eclipse current power generation methods in the Middle East, and dominate fueling for railways as well.
As for specific stocks, a few other picks Citi says should be beneficiaries of the gas on oil trade in the future include Sasol, Paccar, Volvo, and Navistar, although the strategists concede that some are overvalued at present:
Citi believes this trade hasn't even really started to price into the market, but they say these dynamics are a key reason why they are bearish on oil through the end of the decade.
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