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3 Natural Gas Stocks That Should See a Renaissance

Natural Gas
Richard du Toit | Gallo Images | Getty Images
Natural Gas

It takes an optimist to invest in natural gas-levered stocks right now.

The commodity is trading at decade-low prices, raising questions about whether some companies will able to survive long enough to benefit from a resurgence that could take years to materialize. The reality is though that there are plenty of names that are well-positioned to stay alive through the wait.

There are wide-ranging forecasts for when the natural gas price catalysts will combine forces and drive domestic prices higher. But generally, analysts are leaning towards 2016 as the start of it. That’s when Cheniere Energy Partnersis expected to begin commercial operations of a first-of-its-kind, $10 billion U.S. liquefied natural gas (LNG) export plant in Sabine Pass, La.

Private equity group Blackstone has already agreed to invest $2 billion towards the construction of the project. The first two of four gas liquefaction facilities at the site — natural gas must be liquefied at extremely cold temperatures for ease of shipping overseas — will cost up to $5 billion to build. Cheniere is planning to begin construction around April, pending final regulatory approval from the federal energy regulator and closing of the Blackstone financing agreement.

By 2016, the other natural gas price catalysts — demand for the commodity to fuel power generators and natural gas vehicles, among others — should already be in motion. Around that time, there’s also a change that other export terminals will be unveiled in North America as well.

According to James Brick, a macro-energy analyst at research consultant Wood Mackenzie, the U.S. could start exporting on a net basis about 3.2 billion cubic feet a day of liquefied natural gas by 2030, as the nation reduces its dependence on foreign energy sources and assumes a more sophisticated global energy supplier role.

Once the catalysts align, excess domestic supplies should begin decreasing and boosting U.S. natural gas prices. Mike Breard, an analyst with Hodges Capital, reckons that the odds of gas doubling in five years are better than the odds of oil doubling in that time, and he believes the jump in gas could be sudden.

But until then, natural gas prices in the U.S. remain at an over 85 percent discount to oil on a British thermal units-equivalent basis, and oil is trading at more than 40 times the price of natural gas — the largest difference since the deregulation of the natural gas markets that began in the 1980s, according to Croft Value Fund data.

“It is true that high or even average cost pure play natural gas producers might not survive if gas stays at $2.25 per thousand cubic feet for the next couple years,” says Russell Croft, portfolio manager for the Croft Value Fund , which has $900 million in assets under management and is rated a four-star fund by Morningstar.

That said, leading natural gas companies with a big hand in the now more profitable oil space and a cushion to record low natural gas prices will likely be among those with the biggest shot at subsisting through the waiting period for a rebound.

Two stocks that immediately come to mind in this regard are Standard & Poor’s “buy”-rated stocks Chesapeake Energy and Devon Energy . Overall, 12 out of 37 analysts that cover Chesapeake have a “strong buy” recommendation for the stock, up one from last month. Nine out of 31 analysts have a “strong buy” view on Devon, also up one from last month.

One of the largest U.S. natural gas producers, Chesapeake “is resilient if nothing else,” according to Morningstar analysts.

“The firm managed to survive near collapses in the late 1990s and 2008 in part through its knack for creative fundraising,” Morningstar said in a recent research note. “We expect Chesapeake to employ similar financing methods to help fund operations going forward.”

As of January, Chesapeake had 90.4 percent exposure to natural gas and 9.6 percent to oil, according to a Fidelity Capital Markets report, but the company is aiming for 30 percent liquids exposure by the end of 2013, says Michael Kay, energy analyst at Standard & Poor’s.

Meanwhile, Devon’s “superior financial footing should help the firm weather the current low gas price environment and provide flexibility to both aggressively develop existing inventory and capture acreage in emerging plays,” according to a Morningstar report. Devon had 59.6 percent exposure to natural gas and 40.4 percent exposure to oil as of January, according to Fidelity Capital Markets data.

“Should gas double and oil keep going up, to $120 and $130, Devon and Chesapeake as more balanced companies will see benefits on both sides,” says Kay of S&P. “If gas doubles or triples, that’s going to be an extra bonus for them.”

Devon shares closed Friday at $73.73, down nearly 20 percent in the past year. The stock trades at a forward price-to-earnings multiple of 10x, and has an annual dividend yield of 1.1 percent at current levels.

Another natural gas company that’s highly likely to stay alive through 2016 is growth company SandRidge Energy, which also has a crude oil cushion.

Breard, the Hodges Capital analyst, says that SandRidge, as one of the first natural gas companies to venture into oil, is ahead of the game in that area and has been “more successful than most in making the transition from gas to oil.”

Foreseeing the possibility of a decline in natural gas prices, SandRidge preempted the drop and started transitioning to oil more than three years ago despite skepticism over how it was spending shareholders’ money.

The company had been 53.8 percent natural gas and 46.2 percent oil as of January, according to Fidelity Capital Markets. Morningstar analysts note that the contrarian approach that SandRidge has been taking by focusing on the more straightforward, conventional shale drilling opportunities instead of the unconventional emerging shale plays many peers have been chasing, should allow for a more predictable, low-cost development of the producer's assets.

Assuming the launch of the Cheniere’s LNG export terminal comes to pass in 2016, Chesapeake, Devon, and SandRidge could be in lined up for nice windfall opportunity through the potential sale of their natural gas properties to very willing buyers.

Such buyers, most likely those with ties to the LNG export terminal, would likely want to exploit the much higher overseas natural gas prices and sell the commodity abroad; even with the reduction of excess domestic supply, it’s expected that it would be a while before the very low U.S. natural gas prices finally caught up to overseas prices, especially those in Asia and Europe.

“Big companies with ties to LNG export terminals may buy gas reserves from those without such ties and be perfectly happy to drill dry gas wells, liquefy the gas, and sell LNG overseas at twice the U.S. gas price when export terminals are ready to go in 2015 or 2016,” says Breard.

Buyers may include British energy company BG Group, and Blackstone as well as Chevron and Total, which both have contracts with Cheniere to import LNG. Having been long-time supporters of Cheniere, Chevron, and Total should have the ability to sign export contracts with the company, Breard points out.

Breard says buyers could also include Exxon and BP, which all have long-term goals to be in natural gas.

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