Natural Gas vs. Oil Stocks—Picking the Better Buy

Apache's purchase of new drilling acreage and Chesapeake's plans to cut natural gas production highlight the divergence in oil and gas prices that has made stock picking tricky.

Natural Gas

The two announcements, while very different, result from the industry's use of new drilling technologies, which has unlocked oil and gas reserves previously unattainable.

The resulting glut in natural gas has driven gas to a 10-year low resulting in Chesapeake's announcement that it is slashing production by 50 percent. Ultimately, the company will produce less natural gas this year than it did in 2011.

At the same time, Apache said it was buying Cordillera Energy Partners III, giving it access to 254,000 acres that sit on a deeply buried layer of rock in the Granite Wash, on the Texas-Oklahoma border.

News of Apache's latest acquisition helped lift shares of smaller energy companies including Southwestern Energy , Cabot Oil & Gas and Range Resources , as investors speculated that more M&A activity may be on the horizon.

“We haven’t seen many mega-acquisitions as of late, but we’ll continue to see lots of smaller M&A deals both acreage deals as well as corporate M&A,” said Pavel Molchanov, energy analyst at Raymond James.

Weighing on the energy sector, however, Halliburton tumbled after the company said its future earnings could be hurt by the steep decline in natural gas prices, a warning that could be an omen for other firms that rely largely on their U.S. natural gas business.

Citigroup also recently warned that earnings of integrated oil companies will likely disappoint in the coming weeks due to the “harsh refining environment, weak gas demand and lower commodity chemical margins.”

“Our estimates for ExxonMobil and Hess are materially below consensus,” wrote Faisel Khan, director of Citi, in his research note.

Meanwhile, Citi sees long-term opportunities in Petroleo Brasileiro (PBR), Bunge , Chevron and Enersis .

“Gas prices may have bottomed and we might be seeing a light at the end of the tunnel, but that tunnel is very long and the light is very dim,” Fadel Gheit, senior energy analyst at Oppenheimer & Co. said, adding that he does not expect to see a meaningful rebound in the commodity anytime soon.

Gheit said fundamentals still “remain negative” for natural gas and recommended investors to look into the oil-specific companies instead.

“Oil prices will remain at a significant premium to natural gas,” said Gheit, listing stocks such as Marathon Oil , Murphy and Hess as his favored picks. “These make more money, have higher returns, higher dividend yields…and are expected to report fairly strong earnings.”

Still, experts like Michael Murphy, managing partner and CEO of Rosecliff Capital were bullish on natural gas and said investors should prepare for a rebound.

“We’ve had a very warm winter that forced the shorts to jump in on natural gas but that’s going to change because the weather will turn,” said Murphy. “The price of natural gas may go a little lower before it goes higher, but if we get a real energy policy set up, we’ll be able to send natural gas around the globe and these companies and natural gas will go a lot higher.”

Murphy said Cheniere Energy and Cabot Oil are among his favorites.

Questions? Comments? Email us at [e-mail]