For the moment, real life has gotten ahead of me, hence my relative silence. I will be caught up shortly and be capering for your amusement in this spot shortly.
In the meantime, I would submit the natural gas market as a prime example of foolish, overly short term tunnel vision driving valuations. Natural gas has dropped from $6 per MCF to under $3 per MCF. A mild winter, soft industrial demand and the amazing success of modern drilling techniques (fracking) have resulted in a glut of natural gas and the price has dropped to the point that it is no longer economical to drill many wells. Look and listen and you can find many comentators claiming that the world has changed, "this time it is different" and natural gas prices will never recover. Equities in the sector have been under a lot of pressure, with many down a quarter or more in the last 6 to 12 months.
But "funny" things are happening. Many large natural gas producers (including #2 producer Chesapeake ticker CHK) have announced curtailments to their drilling programs (no new wells), shut-ins of existing wells (embargo on!), or both. Despite the hysteria in the media, producers of natural gas are rational actors: if they cannot make money producing gas, they will stop producing it. On the other side of the fence, major end users of natural gas have clearly taken notice of the drop in natural gas prices. Utilities are switching from coal to natural gas, chemical companies like DuPont are talking about trying to lock in the current futures prices for the next several years, and major end users are starting to set up production facilities in the US to use wads of natural gas (something that has not happened in a decade). For example, several methanol and ammonia plants (which basically use just natural gas as a feedstock) are being planned or reopened in the Gulf of Mexico. Finally, Cheniere is a company which spent several years building a large natural gas export terminal in the Gulf that was to have taken advantage of the lower natural gas prices in the rest of the world to supply the high priced US market. Since natural gas is now much cheaper in the US than in the rest of the world ($14 per MCF or so in Japan at the moment), Cheniere is hastily refittng the terminal to export natural gas.
So is it different this time? I find it highly unlikely that the laws of supply and demand have been repealed. The natural gas market has been in the ditch before and lo and behold within a relatively short time the supply/demand balance reset and natural gas prices rebounded. I think that the market is far too negative on the natural gas producers and they probably offer very good vale for patient investors willing to wait for prices to rebound. Natural gas producers are broadly on sale, so one could simply buy stakes in several of them. Names with lots of natural gas exposure include CHK, DVN, UPL, RRC and BBG.
Disclosure: Long CHK equity and options.
You listed a number of stocks, are there any natural gas mutual funds or ETFs worth considering?
ReplyDeletePS: Nice blog. (I know, mum's the word...)
REWahoo
FCG is the only ETF I know of that follows the sector. Alternatively, one could look at things like PEO, which is a closed end fund with a very long history, modest expenses and trades at something like a 13 or 14% discount to NAV.
ReplyDeleteI'm watching for some of the land-based rig & service providers to the O&G companies sell off as the nat gas output levels come down sd you noted. Is there a preference to owning the nat gas heavy companies vs the ones that provide the services? If so, can you explain?
ReplyDeleteBoth can be a good buy, depending on entry price and timing. That said, I prefer the E&P companies that actually own the reserves to the services companies for two reasons. One is that the services companies tend to be even more volatile than the E&P companies and more keyed to drilling activity rather than actual commodity prices. They can only add value by growing their business via new drilling services, buying rigs, etc., whereas the E&P companies have two levers to pull: the price if the commodity can go up, and the E&P company can go out and add more proved reserves via the drillbit. The second reason I prefer the E&P companies is because I view them as part of a hedge against inflation's potential ravages on my portfolio. I will be hurting personally if the prices of nat gas, oil, gasoline, etc. spike, so I would like to have some protection in the form of an asset that spikes in value with them. An equity stake in a company that actually owns and produces what I need is one of the more direct and viable ways to do that.
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