Natural gas will be a game changer for the U.S., which makes depressed stocks in that sector attractive, said Jefferies chief global equity strategist Sean Darby.
Natural gas stocks will drive superior returns in the longer term, he said. Albeit, there certainly remains some risk to the downside given the growing supply of natural gas and need for legislation and approvals from the government.
Darby said making bets on natural gas should be rewarding given the changing dynamics of the energy industry. In his view, shale gas drilling will be a massive disruption to the system that will make the U.S. an important competitor.
The equity strategist is recommending buying natural gas stocks when other energy experts are saying natural gas is on its way to $2 per million British thermal units (Btu), a price not seen since 2002. Natural gas futures were $2.67 at the end of last week. That's a 13 percent decline in one week, and the lowest level in winter in a decade.
Prices have declined on increased levels of supply coupled with a decline in demand. The warm winter has eroded much of the need for natural gas to heat homes. Supply has increased because of new drilling techniques that have allowed companies to reach vast amounts of natural gas that were out of reach not that long ago.
The improvement in drilling technology has led to gathering the resource in a more efficient manner and is ultimately resulting in lower-cost drilling.
While reduced costs certainly help in periods of low prices — on average, natural gas needs to be at least $3 for companies to make money on the drilling — the real play on the natural gas sector is based on the bet that the home-grown commodity will be heavily incorporated in this country's energy policy.
Legislation that stimulates the use of natural gas domestically is expected by many, especially as the U.S. looks to decrease its dependency on other countries for energy. Additionally, several companies are filing for permission from federal regulators to convert their liquefied natural gas (LNG) import facilities into exporting facilities. If these requests are granted, the U.S. could be the largest liquid natural gas exporter by 2020.
That leaves time as the biggest barrier to realizing the opportunity in natural gas companies.
With valuations of natural gas companies at historically low levels, today is an attractive time to buy some of those stocks. Be aware that there risks related to investing in this industry.
Here are a few to consider and research:
Goodrich has shale drilling operations in Eagle Ford, one of the more profitable drilling areas. When the company released its 2012 growth and spending guidance, investors were pleasantly surprised by the reduction in per-well costs of $2.5 million. Goodrich also announced plans for oil production growth of 130 percent to 160 percent. The growth prospects for the company are solid, and the stock should see upside over the next few years.
EOG is expected to see earnings grow an impressive 75 percent in the next five years, according to analysts' estimates. Last week, the stock was upgraded to "buy" at Deutsche Bank on the back of strong production trends from Eagle Ford in the second half of 2011. Increased reserve potential at Eagle Ford is expected to continue as the company makes more efficient use of its space.
Exxon is a less-risky way to play the natural gas sector, given it has more diversified operations. Its XTO Energy subsidiary operates in the Marcellus Shale in the Appalachian basin and has success in extracting natural gas profitably. A dividend yield of over 2 percent also makes for a safe investment in the energy sector.
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