Natural-gas stocks—boom or hot air?

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Natural gas continues to be ballyhooed as part of the solution to U.S. energy needs. The notion of plentiful and relatively inexpensive energy is attractive to investors, and we’ve reported about where to invest to profit from the large amounts of untapped natural-gas reserves.

But a Securities and Exchange Commission rule that took effect Jan. 1, 2010, and was brought to our attention by a July story in The New York Times might curb your enthusiasm. That’s because the rule change means that natural-gas companies’ estimates of untapped reserves might be overstated. The old rule stipulated that a company could calculate only known natural-gas reserves that were adjacent to existing wells. The new rule says companies need only to have “reasonable certainty” that reserves exist—anywhere—to claim them. Unfortunately, companies aren’t required to have an independent third party audit their estimates. That makes it difficult to know how well a natural-gas company really is performing.

Value should be based on sales, not on estimates, says Daniel Gross, who is an economist and Yahoo! Finance’s economics editor. He believes that it’s a potentially dangerous sign that any industry wants to be evaluated based on estimates. He points to the collapse of Bear Stearns and Lehman Brothers in 2008 as examples of the flaws of estimate-based reporting. Gross suggests that you focus on companies that provide goods and services to natural-gas companies, such as pipeline construction and the infrastructure that surrounds production and distribution.