Montreal, Canada

What does Big Oil see in beaten down natural gas?

Natural gas prices are down more than 70% from their highs in 2005. Despite the big crash in prices, two of the biggest energy companies in the United States have now spent a combined $28.2 billion dollars purchasing natural gas assets since last year. ExxonMobil (NYSE-XOM) forked over most of that sum following its purchase of XTO Energy for $25 billion dollars.

Chevron (NYSE-CVX) this week announced it would purchase Atlas Energy (NASDAQ-ATLS) for $3.2 billion dollars. Atlas is a leading producer of gas in the Marcellus Shale, a massive find located in West Virginia.

The bad news for natural gas investors since 2008 is that shale reserves have resulted in a huge glut. Natural gas ranks as the worst performing commodity in 2010 – a banner year for raw materials. Spot natural gas prices have tanked almost 40% this year.

Oil, not gas, is where the money lies now as the former finds strong support north of $80 a barrel. Oil companies continue to make a bundle this year and, in my book, are not selling at prices that reflect $80 or $90 a barrel oil. Refining margins, which plunged following the credit crisis, have also risen markedly in 2010. The U.S. majors are right to be deploying retained earnings into distressed gas assets at these levels; at some point, prices should hit a secular bottom combined with rising demand from China and other economies.

But natural gas margins are being heavily squeezed with many gas companies barely making any money unless they’ve managed to hedge future production at higher prices. Gas has been a loser lately. Canada’s Encana (NYSE-ECA) is one example whereby hedging has managed to soften the gas crash blow.

For contrarian investors, however, natural gas assets are attractive to some heavy-hitters like Chevron and ExxonMobil. Both majors want to secure low-priced assets at a time when new oil reserves are harder to find.

For natural gas, my favorite remains Encana.

ECA is one of the best natural gas companies in the world with strong management, a great track record and rising long-term dividends. The stock borders a 52-week low and pays about a 3% annual yield. Still, you’ll need patience. Natural gas is poised to stay depressed for a while until some sort of demand catalyst finally drives the price much higher.