Back in the middle of the year oil was sitting around $140 a barrel and gas was $4.50 a gallon. It took me about $50 to fill up the tank of my Corolla — which really got my blood boiling.

I’m still bitter about who actually got my money. Some of it surely went to the Middle East, some of it ended up with IOCs, and a portion of it went to our government through taxes — those are three charities I normally wouldn’t hand a donation to.

So here we are in the third month of 2009 and oil is sitting around $50 a barrel — which is pretty cheap, in my opinion. In fact, some modest estimates put oil at $75 in the next three months.

So with looming price increases, do we have to sit back and live with increasing prices at the pump? I don’t think so…

There’s a simple way that you can control the price you pay for gas over the next five years. Actually, you could be paying the 2009 price in 2014. And heck, you could even lock in today’s price for the next 10 years… that’s like paying 2009 prices through 2019. Had you made this same move 10 years ago (in March 1999), you’d be saving 48% at the pump — so basically, every mile you drive would cost half. That’s not bad at all.

Of course this won’t make any sense if you think gas prices are high today. You’d have to assume that prices are going to rebound and prices at the pump will be much higher in five years. Honestly, I’d say that’s a pretty safe assumption.

So if you’re still onboard with this idea, I’ll get down to the details — but first, let’s look at today’s gas prices…

The Gas Price Debate

As it stands, the current national average is $1.92. Take a look at the 10-year chart:

This chart shows the 10-year bull market in oil and gas prices. It also shows the huge correction in prices since July 2008. But the one thing that this chart clearly portrays is that even with major corrections, the price of gas is on the way up. Waaaaay up.

Frankly, every time I fill up my Toyota Corolla for $19 bucks a tank, I get a little giddy. Compared with 2008’s price run-up, it feels like I’m stealing every gallon I get.

That’s a feeling I want to have for years to come.

So how’s it possible to keep this low price for the next five or 10 years?

Hedging Without the Hedge Fund

Hedging has been around for centuries, but interestingly enough, not many consumers use it — which I think is a mistake.

Hedging is nothing more than a simple tool to offset risk.

The classic example of hedging is when a farmer wants to make sure he gets a good price for his crop. By hedging his crop, he’ll be able to lock in the price he receives. And that makes perfect sense: If I were a farmer and put my life into growing corn, I’d be damned sure to guarantee a fair price for my harvest. Otherwise, I could get burned when the harvest came in — imagine getting half the price you expected.

Another example is when airlines hedge the price of crude oil or jet fuel. Much like a farmer, airlines have a lot of risk. That’s why most major airlines use hedge contracts to control the prices they expect to pay for their fuel. It’s just smart business.

But you don’t have to be a large-scale farm or airline company to get involved.

Hedging is simple, and as long as you have risk (which you do if you intend on driving over the next five-10 years), you can easily protect yourself against the rising price of gasoline.

A Gas Hedge for You…

So what’s the best way to hedge?

In lieu of owning your own gas station and controlling your own prices, here’s what you can do: Buy into the United States Gasoline Fund (UGA: NYSE ).

The fund has been around for a little over a year and offers a pure way to hedge the price you pay at the pump.

Each share you buy could act as your personal hedge and gives you a way to ride the rising cost of gas. As the price of gasoline goes up, this fund will also rise — it’s an effective way to offset the price you pay at the pump! And as long as you hold shares, you’ll be completely protected from any movements in gas prices.

Here’s what the prospectus has to say:

“The investment objective of USG is to have the changes in percentage terms of the units’ net asset value reflect the changes in percentage terms of the price of gasoline, as measured by the changes in the price of the futures contract on unleaded gasoline.”

That’s it. There are no CEOs or earnings announcements. The fund just follows the price of gasoline with the use of futures contracts. So it’s safe to assume that if gas goes higher, this fund will follow.

Take a look a the one-year chart:

As you know, gas prices have taken a beating over the past year — which has made for some cheap fill ups lately. And that’s exactly why UGA has also fallen. But I don’t expect prices to stay low — especially not over the next five or 10 years.

That’s why now may be the perfect time to hedge your gasoline usage and pick up some shares of UGA (currently trading around $24 a share). As the price of gasoline rises, so will the price of your shares.

You’ll benefit in every move gas makes on the upside, so in five years, if the price of gas triples, you’ll have that three times your investment. That’s profit that you can use to offset (hedge) the price you’ll be paying at the pump!

Under-$2 gas for the next five years sounds OK to me.

Stay ahead of the curve.

Regards,
Matt Insley

Surprise! Higher Gas Prices Are Coming was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

For some, the weather outside has been frightful. For others it has just been bizarre.

Among other things, January brought us 70 degree temperatures in New York City’s Central Park; New England forsythias in joyous springtime bloom; snow in Malibu; more than $700 million worth of freeze damage to California citrus crops; Colorado cattle trapped by 15-foot-high snow drifts; and, last but not least, Midwest ice storms that killed at least 14.

With apologies to Dickens, January was both the warmest of times and the coldest of times. Overall, 2006 was the warmest year in over a century for the continental United States. The mild temperatures enjoyed by the East-even as the West got gob-smacked by Old Man Winter-were enough to send natural gas stockpiles soaring. (No need to heat the house when it’s t-shirt weather outside.)

But now it looks like Old Man Winter could be rolling up his sleeves. Joe Bastardi, Chief Forecaster for AccuWeather.com, believes the whole country is going to get walloped. “Those who think that winter 2006-07 is going to remain mild are in for a shock,” he says. “Winter is likely to come with a vengeance.” Bastardi sees shades of winter 1977-1978, when a warm beginning led to a blizzard-pounding finish.

If Bastardi is right, natural gas storage levels could plummet in short order-reminding Wall Street once again how quickly situations can change. If he is wrong, of course, natural gas will remain mired in negative sentiment for the time being.

Climate change fears suggest a trend of milder winters-a negative for natural gas. But the flip side of that coin is greater temperature volatility and stronger legislative pressure.

Extreme weather patterns (like snow in Malibu, for example) require a larger supply buffer to absorb demand spikes when the outliers hit. Temperature volatility thus lessens the perceived “margin of safety” in existing storage levels. (The more things can swing, the more buffer you need.)

In addition, the more mild and wacky winters we see, the more determined world governments become to “do something” about carbon emissions. This green calculus gives natural gas a leg up on its carbon-spewing rival, coal. While coal is the electricity-generating champ from a financial cost standpoint, natural gas is cleaner and less carbon-intensive, making it the environmentally desirable choice.

Coal will likely remain the electricity king for some time, thanks to its abundance and low cost, but will also cede ground at the margins due to its reputation as a polluter and CO2 spewer. Nuclear power is set to expand its electricity role, but regulatory hurdles and lengthy construction times mean that growth will happen relatively slowly. Solar and wind are ramping up, but starting from a miniscule base. These factors give natural gas a consistent demand edge, in both China and the United States, that will last for quite a while.

All this, too, comes on top of the fact that in terms of depletion rates versus discovery rates, North America is running hard just to stay in place. The new wells are just not keeping up. Elsewhere, industry experts believe the global shortage of liquid natural gas (LNG) could persist until 2011, in part due to the political risk of LNG terminals and the high cost of plant construction. Furthermore Canada’s oil sands expansion plans will suck up a larger portion of that country’s natural gas production over time.

These natural gas musings are the backdrop for the latest Outstanding Investments recommendation.

This drilling company is a rare find: a small-cap growth stock with a beaten-down value profile.

Normally it’s very tough (if not impossible) to find small-cap companies with excellent growth prospects, strong cash flow, and minimal long-term debt trading a mere twenty to thirty percent above book value. (This company is trading just under $16 as of this writing, with a $396 million market cap. Book value is $12.95 per share according to the Wall Street Journal. )

Most of the time, companies trading close to book have an outlook ranging from “blah” to “ugly.” If a business sells for a just few dollars more than what the parts are worth, the natural assumption is that something is very wrong with that business.

If that same business is well run, making solid profits, has the means to retire its long-term debt in a short period of time, and could theoretically generate enough cash to buy back all its own stock in the next few years… now you’ve got a real head scratcher on your hands.

Except in this case, the mystery has already been cracked. We know the problem is the manically gloomy sentiment surrounding natural gas.

This is a small-cap land driller provides contract drilling services-land rigs-to oil and natural gas exploration and production companies, with ongoing contracts in Oklahoma, Texas, Kansas, Colorado, and North Dakota.

Approximately half of their customer base is publicly traded-well-known entities like Devon Energy and Chesapeake Energy. The other half are strong independents. Their customers have at least two things in common: they are committed to the long-term bullish case for natural gas, and they are committed to drilling.

Between December 15, 2006 and January 11, 2007, the shares of this company were pummeled, registering a 30% decline in less than two months. The selloff came during a period of general carnage for the drillers, as oil declined and natural gas fears escalated with the persistence of mild winter weather.

Things were orderly at first, and then Nabors Industries-a large competitor, and one of the biggest land drillers in existence-announced a fourth quarter earnings warning on January 3. Nabors went into freefall at that point, and this company followed.

At the worst point of the decline, the spread between this driller’s share price and book value shrank to about sixty-seven cents…less than the company’s third quarter diluted earnings of 70 cents per share.

When the implied value of the entire business operation is compressed to less than one quarter’s worth of earnings, you know there is some panic in the house.

Legendary value investor Ben Graham liked to talk about “Mr. Market,” analogizing the stock market to a human being subject to fits of optimism and depression. Thanks to the dominance of fast money and short-term time horizons, Mr. Market is a bit of a drug addict these days, downing copious quantities of quaaludes and methamphetamines. When Mr. Market gets exceptionally out of whack, opportunities arise like this one.

The real worry for companies like this and Nabors is what’s happening in the land rig market. Nabors’ cut of fourth-quarter earnings guidance, which it blamed on slowing North American gas markets, led to dire scenarios of collapsing day rates and rigs sitting idle as result of a glut.

In Outstanding Investments’ opinion, these fears are overblown. There is fair reason to have concern, but nothing to justify the crush of pessimism that has weighed down the drillers so heavily. That is, if one understands the basic realities of peak oil and the compelling long-term case for natural gas.

In regard to rigs and day rates, this driller also stands out for the quality of its management and farsightedness of its strategy. It keeps close tabs on market conditions, and is careful not to “compete with itself” by putting out more rigs than the going market can support.

When the market is less conducive to putting out refurbished rigs, the company scales back and uses its cash flow to diversify into other complimentary businesses, like workover rigs-the mobile machines that handle cleaning, service and maintenance for wells already in production. Their recent acquisition of Eagle Well Service is an example of expansion in this direction. Not to mention they are also mulling over the possibility of international expansion as conditions and opportunities warrant.

This driller reports good visibility with its clients; the CEO reported on the third quarter earnings call that there seem to be no issues with drill budgets, and “if anything we’ve seen a push to continue to drill.” Because of their high-tier focus on support, service and safety, they also enjoy stronger relationships with clients than many of its smaller independent competitors. This adds a layer of stability to revenues, as the less established fringe players are the ones to see their rigs idle first in adverse market conditions.

The land rig market is not without risk in the coming months, but the potential reward seems well worth it. While this driller has already bounced off its oversold extremes, it is still trading under its $17 initial public offering price as of this writing-and this comes with excellent management and excellent results.

Book value acts as a floor underneath the stock-if worst comes to worst, a vulture investor could break up the pieces and sell them off for $13 a share or so, if not more under the right circumstances. But that isn’t likely to happen by any stretch of the imagination. What is far more likely, in our opinion, is that day rates and rig utilization will stabilize and resume their upward trend in due time, and they will continue to grow and thrive.

Of course, if Mr. Bastardi of Accuweather is right in his weather predictions, sentiment for the land drillers could turn extremely quickly. At a current price to earnings ratio of less than eight, they could theoretically see 50% or more upside simply by way of removing the cloud of pessimism overhead.

Even if the weather remains mild and the sentiment adjustment a ways off, the natural gas case is solid-and this driller looks worth holding on to for “multi-bagger” upside potential in the years to come.

Till Next Time,
Justice

February 9, 2007

Land Ho was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.