Think C-O-G to Buy Cabot Oil and Gas

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Ten years ago, natural gas exploration and production in Appalachia generated little excitement.  Not much gas and no easy way to get it deflated enthusiasm for developing this resource.  Then, the combination of hydraulic fracturing (“fracking”) technology, improved horizontal drilling techniques and estimates of abundant gas reserves from geologists at Penn State and SUNY Fredonia changed everything.  Now, there was an estimated 50 trillion cubic feet of recoverable natural gas and the means to recover it.  Natural gas drillers in the Marcellus Shale regions discovered arguably the largest natural gas finds in the country.  Wholesale drilling ensued and some landowners literally became overnight millionaires.  Despite recent declines in natural gas prices, Cabot Oil and Gas (NYSE: COG) has kept right on producing and I think offers an attractive investment.  My reasons for investing are summarized by the company’s stock symbol C-O-G. 

C - Cost of Natural Gas Production and Transport 

This is interesting.  According to Mel Daris of Seeking Alpha, COG enjoys ridiculously low gas production costs.  The company’s CFO estimates its breakeven point is less than $2/mbtu (or $2.05/Mcf), Transportation costs for COG run as low as $0.50 per tcf compared to $1.40 per tcf paid by competitor Carrizo Oil and Gas (NASDAQ: CRZO).  All this means even at today’s low gas prices, COG can still make a buck on its ever growing production (more on that below).  

O - Opportunities for Gas Sales

According to the US Energy Information Administration, the number of electricity generators in the US using natural gas as a fuel rose from 5448 in 2009 to 5574 in 2011 with more to come in 2012.  Year to date figures show that electricity generation consumed 9.1 tcf of natural gas, up from 7.8 tcf from the previous year.  Given the price advantage over oil and coal, I believe this trend of increasing natural gas consumption will continue.  Even better, in 2011 there was a 50% increase in natural gas pipeline exports to Mexico at an average price of $4.18/Mcf.  I anticipate gas exports growing since US natural gas holds a price advantage over Mexican gas and Mexico is expanding its use of natural gas for electricity generation.  Lastly, the New York Times reports Dow Chemical (NYSE: DOW), which uses natural gas in plastics production, has identified 91 new or proposed manufacturing projects due to cheap natural gas.  With increased demand will likely come increased revenue and earnings. 

G - Gas, Lots of Gas

Last September, COG announced record gas production from its Marcellus shale operations.  They achieved this production not by drilling more wells, but by extracting more gas per well.   COG’s pipeline partner, Williams Partners LP (NYSE: WPZ) had improved pipeline operating efficiency and thus allowed the greater gas production by COG.  According to its most recent 10-Q report, natural gas production rose 45% from the previous year.  COG also claims to have 14 of the most productive 20 gas wells in the Marcellus region.  All told, COG has a reported three trillion cubic feet of proven natural gas reserves in Marcellus shale, up from two trillion cubic feet in 2009.


<img height="359" src="" width="509" />

As the above chart shows, proven natural gas reserves in the US have steadily increased and Marcellus Shale is one reason why.  I suspect COG’s proven reserves will grow with time. 

So why COG and not someone else?  Two competitors would include Carrizo and Chesapeake Energy (NYSE: CHK).  Both have operations in the Marcellus shale as well as other geographic locales.  Both companies have had their stocks clobbered and perhaps for good reason.  According to the same NY Times article mentioned earlier, Chesapeake and others have borrowed heavily to produce gas with contract terms that mandate ongoing drilling even if it makes no economic sense.  Read for yourself here.  Cabot was not mentioned in the Times article. 


<img height="488" src="" width="800" />

Chart courtesy Yahoo! Finance. 

Bottom Line:

Abundant natural gas gives the US a cheap source of energy that fuels utilities, industry and vehicles.  Given the wholesale production, it’s no wonder natural gas prices have declined and with it, the earnings of many natural gas producers.  However, COG has bucked this trend with low production/transportation costs and financing terms that apparently don’t compel it to produce gas when it’s not profitable to do so.  Yes, its PE ratio is amazingly high.  Yes, immediate past earnings seem unimpressive.  Yes, an earnings disappointment could clobber the stock.  Yes, its dividend is extraordinarily low (frankly, I wonder why they even bother).  However, year over year earnings and profits have grown and future earnings look good, particularly given the growing demand for natural gas.  Given ridiculously low production costs, multiple sales opportunities and plenty of gas to sell, I think Cabot is well positioned to profit from the future growth in natural gas use.

Fellow Foolish blogger Matt DiLallo doesn't share my enthusiasm for COG.  That's OK.  You can still read his analysis here.

dylan588 has a position Cabot Oil & Gas. The Motley Fool has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, short JAN 2014 $15.00 puts on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. 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.

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