Overly Generous Fraking Estimates and Bullish Alternative Energies
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The energy world is a complicated place. The recent natural gas fraking boom has upset the entire energy sector, as alternatives have started to suffer. Yet in any booming market there is room for caution. Recently industry insiders and investors have started to criticize the models used to estimate ultimate recovery (EUR) figures for shale wells. Given the sharp decrease in the production from horizontal shale wells over the first couple years of production, it is not unconceivable that a number of natural gas exploration and development firms will eventually go bankrupt. If firms sell the majority of production from shale wells at the current low prices (which are not enough to support the total costs per well) then even an increase in natural gas prices may not be enough to bring these wells into the black.
How Coal Will be Impacted
With the advent of flexible power plants which are able to use coal or natural gas, and the plethora of natural gas supplies in the U.S., thermal coal is being priced relative to natural gas. Utilities are starting to compare both fuels on MMBTUs (million British thermal units). The break even point for natural gas varies greatly, but given more realistic figures around $5.6 MMBTUs. The price of coal will substantially increase from the current estimates of $2.4 MMBTUs when natural gas returns to more reasonable prices.
Peabody Energy (NYSE: BTU) is one of the stronger coal producers. The major downside is that they have recently increased their operations in Australia to take part in the booming Chinese market. This coincided with the recent approval of an Australian carbon tax and the continued structural issues concerning China's reliance on fixed investment to drive GDP growth and social stability.
The P/E ratio of 8.12 is very reasonable and the total debt to equity ratio of 1.09 is not outrageous. With a yield rate of 1.2% the firm has is less attractive than Alliance Resource Partners' 6.6% yield. But Alliance is an MLP, and potential investors must be willing to deal with the extra tax complications which an MLP entails. The gross margin of 29.70% and profit margin of 10.40% show the profitability of the BTU in the midst of current difficulties.
CONSOL Energy (NYSE: CNX) is another coal producer, but its natural gas assets make it an interesting play. The firms' Marcus and Utica Shale assets should make potential investors pause as the long term viability of such shale assets is still not 100% clear. Regardless, their total debt to equity ratio of .83, gross margin of 37.20%, and profit margin of 10.30% are positive figures. Though they appear to be a solid firm, based on these metrics I believe investors would be wise to wait until natural gas returns to more reasonable prices. Given the sharp production decreases of horizontal shale wells these shale assets could become a limiting factor.
Market Vectors Coal Etf (NYSEMKT: KOL) is another vehicle to invest in coal. A large portion of the firm's assets are invested in the Chinese market, which has different dynamics than the U.S. market. The expense ratio of .59% is higher than those of simple broad-market ETFs, but around the normal rate for specialty ETFs. For long term investors I doubt that this ETF is the best way to invest in the U.S. energy market, as its Asian assets have complications that can drag down returns.
BTU's Australian assets will have an impact of the company's bottom line, but at least the firm has the ability to play the whole South Pacific market and is not subject to direct influence of the Chinese government. China Shenhua -H and China Coal Ene -H are both Chinese state-owned coal miners that are in the top 10 holdings of KOL.
How Solar Will be Impacted
In the long run, solar companies like First Solar (NASDAQ: FSLR) are also poised to benefit from the repricing of natural gas. Out of all of the solar manufactures, this firm is one of the strongest. Their total debt to equity ratio of .15 and quick ratio of 1.40 show that the firm is not drowning in mountains of debt. Its thin-film solar technology has helped it to achieve 26.8% margins and positive EPS in the last quarter. With the recent imposition of import tariffs on Chinese panels the company will gain extra footing in the U.S. market and be able to continue their growth as a leader in the solar industry.
Overly optimistic estimations of shale wells is something that energy investors should be intimately aware of. Natural gas may be profitable at current prices based on variable costs, but when total costs are used the picture is not as rosy. Given the steep declines which shale wells face in their first years of production, low prices have the possibility to bankrupt firms down the road. Investors should be attuned to this situation and be sure to diversify their energy portfolio with non-natural gas assets to help decrease risk and increase stability.
MrCanadian1 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend First Solar. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.