Are You Ready for the Natural Gas Rebound?
Stephen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
So we all know natural gas prices are near a 10-year low and most companies dealing with natural gas production have been shellacked by the market. Any of us who believe in an inevitable natural gas rebound are looking for opportunities in these companies. Oil and natural gas companies are popular choices, such as Chesapeake Energy, Exxon Mobil, and Ultra Petroleum, but I'm focusing my research on the companies that build and service the wells these companies own. My theory is any single oil and gas company can meet unexpected headwinds, but a service company is spread across numerous independent and major oil and gas companies and is therefore a safer play.
Checking the Natural Gas Weather
My thesis is based on the notion that natural gas prices are at or near a bottom and will rebound along with demand. This increase will prompt oil and gas companies to increase capital expenditures on new or existing natural gas wells. So first, I'll address the price of natural gas. All of my research and figures come from the U.S. Energy Information Administration, http://www.eia.gov/. The average monthly price of natural gas in March 2012 was $2.18. The 2013 forecast price is $3.40, which has been recently revised down from $3.96. I can see that prices are projected to increase, although at a slower pace than previously estimated. One positive result is there has been a significant gain in the natural gas market share in terms of electricity generation at coal's expense. This year's natural gas share of total electricity generation is estimated to jump from 24.8% to 29.2% while coal fell from 42.2% to 38.3%. Environmental regulations against coal generated electricity could further push this trend.
Next I'll look at other factors affecting demand. I already touched on the increased consumption from the electric power sector (20.83 billion cubic feet per day in 2011 to an estimated 24.15 in 2012). The mild 2011 winter was a significant factor in the decreased demand and resultant decreased price. Residential consumption was 13.12 billion cubic feet per day in 2010 and dropped to an estimated 12.47 in 2012. As a result, the country's current working inventory of natural gas is nearly 50% above its 5 year average. Another major opportunity for increased demand is coming from the transportation sector. According to the Department of Energy, there are currently about 1,000 compressed natural gas fueling stations, and according to Natural Gas Vehicles for America, http://www.ngvc.org/about_ngv/, there are about 120,000 natural gas vehicles in the U.S. and 14.8 million worldwide! NGV Global, http://www.ngvglobal.com/, estimates there will be 50 million natural gas vehicles worldwide in 10 years. Increased utilization of natural gas vehicles could result in a significant jump in demand. In 2011, vehicle consumption of natural gas accounted for just 0.1% of consumer consumption of natural gas. There's a lot of room to grow there.
I think the biggest factor in the future of natural gas in the United States is going to be politics. I'm hopeful that natural gas has found something of a sweet spot and has a lot of support from both sides of the aisle. Energy independence is one of those political buzz-phrases that is actually being realized as a possibility with the developments in directional drilling and hydraulic fracturing. There are some serious environmental concerns, but my understanding is they have more to do with how the chemicals used in fracturing are disposed of and less to do with the actual drilling process. Environmentalists may also support natural gas over coal and oil because it generates significantly less hydrocarbons.
Finally, I want to look at a couple companies that build, maintain, and service oil and natural gas wells. The four I'm going to focus on are Schlumberger Limited (NYSE: SLB), Halliburton (NYSE: HAL), Baker Hughes (NYSE: BHI), and RPC (NYSE: RES). I'll start with a glance at a few fundamental metrics.
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There's a lot to like right off the bat. All four have been beaten down by the market and are well off their 52 week highs. They all generate great cash flows, pay dividends, and have less relative debt than most oil and gas companies. Their operating and profit margins are generally superior to the oil and gas companies as well.
Schlumberger is the largest and most diversified of this bunch with exposure to the Americas, Europe, Africa, the Middle East, and Asia. The offer a true 'soup to nuts' service, from surveying possible drill sites to oil and gas distribution, and everything in between. One possible downside is only 32% of their 2011 revenue was from operations in the United States, so there is less exposure to an American natural gas boom, however, they stand to reap the biggest rewards if natural gas stagnates in the U.S. while the rest of the world increases production.
Halliburton has great American exposure, roughly 58%, although they are still trying to get out from under the shadow of the Deepwater Horizon spill. The trial to apportion blame and damages has been pushed to 2013, and Halliburton's latest 10-K report states Halliburton is unable to estimate the ultimate financial impact of the trial. Otherwise, this company looks to benefit greatly from an American natural gas rebound.
Baker Hughes is another major American player with some exposure to refining and distribution as well. In 2010 the company acquired BJ Services, a leading provider of pressure pumping (think hydraulic fracturing), in order to meet customer demand. The company is very comparable to Halliburton without the harbinger of the Deepwater Horizon spill litigation hanging over them. Baker Hughes also wins points in my book for publishing the Rig Count data (more on that further in the article) on their Investor Relations website.
RPC Inc. is a smallest player on this list at a $2.3 Billion market cap and little international exposure. They have a great balance sheet, and the 3.1% yield is a nice bonus. Unlike the previous companies, RPC has minimal exposure to off-shore operations. This is a potential positive because further federal regulations negatively impacting offshore drilling will not impact the company's business. 55% of their 2011 revenues came from pressure pumping services, so their future is directly tied to continued development of horizontal wells in the United States.
A key metric to look at when evaluating the future of these companies is rig count. More rigs = more business. The rig count trend in the United States is a mixed bag right now. The long-term trend is healthy, growing from an average of 1,155 in 2001 to 1,875 in 2011. However, the rig count has declined every month from a high of 2,017 in October 2011 to 1,962 in April 2012. Headlines around these figures have certainly contributed to the punishment of these stocks lately, but I'll point out that the average rig count for 2012 is still 100 rigs higher than in 2011, even after the 6 months of decline. The situation is nearly identical for the worldwide rig count.
The days of market volatility for natural gas companies are certainly not over, however, I personally believe the long-term future is bright for the industry as a whole. Are you interested in any of the companies mentioned in this post? Please leave a comment to further the discussion.
drfrank1 owns shares in RPC. The Motley Fool owns shares of Halliburton Company. Motley Fool newsletter services recommend Halliburton Company and Schlumberger. 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.