For five years, I’ve been telling you about big opportunities in the U.S. natural gas industry.

New technologies have unlocked a glut of natural gas supplies. That oversupply has crushed natural gas prices and has left the share prices of many natural gas producers deeply depressed. My readers and I have cashed in on the wreckage with E&P partnerships, “PUD hoarders,” high-income natural gas trusts, and more.

While I’m still holding some of my favorite natural gas plays… and while I’m bullish on the sector for the long-term… there’s a danger lurking here that could smash some companies in your portfolio.

[ad#Google Adsense]The dirty secret in the natural gas industry is that you can’t make money producing natural gas when prices are below about $6.25 per thousand cubic feet (mcf). But prices have wallowed below $6 since 2009… And they’re about $4.50 right now. So how are all those companies staying afloat?

The secret is natural gas liquids (NGLs). NGLs are sort of a cross between oil and natural gas. They include stuff like ethane, propane, and butane. They’re used to make chemicals and to fire your grill.

Some natural gas wells will produce these NGLs as a byproduct. And they can make wells a wonderful profit center.

Right now, NGLs sell at a big premium to natural gas. The price of a barrel of natural gas liquids sells for between 25% and 50% of the price of a barrel of oil. And that extra cash from NGLs is the only thing keeping many natural gas producers solvent.

Take Petrohawk (HK) for example. This $6 billion natural gas company produced 63 billion cubic feet of natural gas equivalent in the third quarter of 2010.

The company grossed $409 million for the quarter… or $6.50 per mcf. But it sold its natural gas for just $5.19 per mcf. That means 20% of its revenue came from somewhere else.

The company produced one barrel of liquid for every 126 mcf of natural gas. And it made the difference between bankruptcy and a thriving business.

But that extra cash could disappear in a hurry…

The production of NGLs is at a decade high. In 2001, natural gas liquid production soared to over 14.5 million barrels. That was the highest volume in the history of U.S. natural gas production.

Today, we’re close to that all-time high again. Production is up over 14.3 million barrels.

NGLs are generally a “local” market, not a worldwide market like crude oil. And with supply where it is in the U.S. now, John Richels, CEO of giant energy firm Devon Energy, believes ethane could fall 45% from its current price. That would be 64% below its high earlier this year.

Ethane makes up over 30% of a standard barrel of NGL. If things really get bad, we could see the prices of other NGL components take a similar hit.

If NGL prices crash, it will knock out a needed source of revenue for many large natural gas producers. Drillers, service companies, pipelines, and exploration companies with lots of exposure to NGL production will suffer big share price declines… In this volatile sector, that can amount to 50% drops.

That’s my worst-case scenario. So far, NGL prices have held steady. So for now, all you need to do is mind your trailing stops on natural gas investments.

Next week, we’ll take a look at some of the most vulnerable production companies. These are stocks with lots of NGL exposure. They’re worth watching closely… And they’ll be our warning signal if NGLs start to fall in price.

Good investing,

— Matt Badiali

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Source:  The Growth Stock Wire