The natural gas industry may now be hurting from rock-bottom prices, but if it is able to fully exploit fracking technology and estimates of massive shale gas reserves turn out to be accurate, there will be few losers and many winners — from exploration and extraction companies to pipeline construction and services companies.
Much of the recent weakness in gas prices, which hammered industry-players' stock prices, was from lack of demand caused by an exceptionally mild winter, says Morningstar analyst Mark Hanson.
He believes normal weather conditions in the future should double the price to $5 per 1,000 cubit feet, a level that will provide healthy profits and isn't at odds with the supply boom
“There are sufficient opportunities within most companies’ portfolios that if gas prices recover meaningfully, they can ramp up production fairly easily,” he says.
Such a scenario suggests investors willing to ride out a rocky 2012 may find plenty of opportunity among companies in the sector, which has been trading at multi-year lows.
“Some people have an intermediate-term bearish view and want nothing to do with anything associated U.S. natural gas,” says Kurt Hallead, co-head of Global Energy Research at RBC Capital Markets in Austin, Texas. “The contrarians say that when everything’s been beaten down because there’s excess supply of natural gas and the economics of drilling are so lousy — well, when everybody else wants to get outta' Dodge, I want to get in."
Energy companies with the bulk of their production coming from gas (versus oil) are Cabot Oil & Gas, Southwestern Energy and Range Resources.
Hanson believes Cabot and Range have high-quality properties and can make money in the current environment, but investors have bought into their stories and the shares are close to his estimate of fair value.
Southwestern, he says, has higher costs and needs improving prices to significantly boost profits.
Chesapeake Energy also has excellent properties, but is bogged down by a heavy debt load and the scandal of CEO Aubrey McClendon.
Hanson’s top pick is Ultra Petroleum, a company nearly 100 percent reliant on gas from a field in Wyoming and the Marcellus shale field in New York, Ohio, Pennsylvania and West Virginia.
The company has held the line on costs and has 10 years’ worth of inventory, says Hanson, who believes the stock's fair value is $50, compared with the recent $18 trading level.
Andrew Coleman of Raymond James & Associates in Houston says energy companies whose share prices have suffered most recently were slow to adapt their production for natural gas liquids, which he describes as “somewhere in between” oil and gas.
Southwestern Energy, which Coleman rates “market perform,” “is a very well-known and well-run gas company, but they have been slow in making the transition.”
By contrast, QEP Resources , which relies on gas for 80 percent of its production, “has done a good job” in selling natural gas liquids, says Coleman, who has a “strong buy” on QEP.
James C. West of Barclays Capital, who covers the energy-services sector — the companies that provide equipment and supplies for energy exploration, or perhaps even do the drilling themselves on an outsourced contract basis — believes “the next megacycle” for the services industry is getting under way, and the stocks in the sector will “significantly outperform” the broaderstock marketover the next several years.
Barclays’ favorite stocks are the “big four” large-capitalization, diversified companies that have international exposure in addition to their operations in the U.S. and Canada — Schlumberger and Halliburton are the firm’s favorites, followed by Baker Hughes and Weatherford International .
Barclays also recommends two equipment companies, Cameron International and National Oilwell Varco , which have high backlogs of orders.
RBC's Hallead lists Cameron as a firmwide “top pick.” Cameron’s equipment can be used by either the oil or gas sector, insulating it from problems in one or the other.
It also has a “midstream infrastructure” business that’s set to benefit as federal and local governments' focus more on pipeline safety, and is trading at a 30 percent discount to its five-year average, based on forward earnings.
Investors can’t merely use a dartboard approach to pick the long-term winners in the sector, however.
Coleman says if the low-price environment persists, the quality of gas a company produces, its lack of debt and its proximity to market will matter even more. (There are greater costs of transmission for remote gas fields that are hundreds of miles from large population centers.)
“If you’re a Marcellus producer 200 miles from New York City, that probably gives you more of a margin of safety,” he says. “If you don’t have a giant balance sheet sitting behind you, or if you’re not right next to market, those guys could be a little more challenged.”
Hallead says in the energy-services sector, the companies most likely to be “challenged” are those that are solely focused on land-based drilling in the United States, where rig counts are expected to show just a small increase this year.
“You have no more pricing power, and you can only grow your business by volume, which is growing just 5 percent.”
Disclosures: The above analysts Hallead (RBC) Hanson (Morningstar) and Coleman (Raymond James) explicitly say they do not own shares. Barclays' compliance says West "has not disclosed" that he owns shares.
RBC did not receive compensation from Cameron in the last 12 months.
Raymond James has not received compensation from the two companies Coleman mentioned. Morningstar has not received and does not seek compensation from issuers.
Barclays Bank PLC and/or an affiliate have received compensation for investment banking services from Baker Hughes Inc.(BHI), Weatherford International Ltd (WFT) and Cameron International Corp (CAM) in the past 12 months.
Barclays Bank PLC and/or an affiliate have received non-investment banking related compensation from Baker Hughes Inc.(BHI), Weatherford International Ltd (WFT) and Cameron International Corp (CAM) within the past 12 months.
Baker Hughes Inc.(BHI), Weatherford International Ltd (WFT) and Cameron International Corp (CAM) are, or during the past 12 months have been, investment banking clients of Barclays Bank PLC and/or an affiliate.
Baker Hughes Inc.(BHI), Weatherford International Ltd (WFT) and Cameron International Corp (CAM) are, or during the past 12 months have been, non-investment banking clients (securities related services) of Barclays Bank PLC and/or an affiliate.