Who Wins if Natural Gas Prices Explode?
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
“The market can stay irrational longer than you can stay solvent.” The popular investing quote by John Maynard Keynes is about the best way I can explain the current price of Natural Gas. With oil prices still well over $100 a barrel which is giving us prices at the pump of over $4 a gallon; it seems irrational to me that another equivalent energy supply is trading at around two dollars and change. Based on energy equivalent basis oil and natural gas should trade at a six to one ratio, though it’s typically traded at a ratio between eight to twelve times. Depending on where prices are at any given day, it’s recently been as high as sixty to one. Something has to give and when it does who stands to win?
The problem that most investors face is in trying to pick that winner, if and when the turn does come. It seems that each day another potential opportunity presents itself. One company that I’ve been watching with both interest and disgust is Chesapeake (NYSE: CHK). There are few CEO’s in America that have polarized investors like Aubrey McClendon has of late. His company however looks cheap at first glance as it trades at just eight times trailing earnings and has tremendously valuable assets though the company seems to be trading solely on the headlines. The problem is that’s not going to change unless McClendon either parts ways with the company or natural gas prices rise to the point where the company is just gushing cash flow for investors. Right now the company is saddled with a lot of debt and has a CEO who seems to only be looking out for his own interests. There are too many unknowns here to make them worthy of any investor’s cash.
One company that I do really like is Devon Energy (NYSE: DVN). They are a top-five producer of natural gas and have done a good job of late consolidating their portfolio by selling off their non-core international assets. They are investing heavily in oil and natural gas liquid projects and I found it interesting to read that they currently produce 250,000 barrels per day of liquids which is the number Chesapeake is seeking to hit by 2015. While the oil and liquids focus of Devon has been benefiting shareholders given the current market, Devon isn’t currently drilling any dry gas wells so if natural gas prices ever do rocket higher Devon is going to have to play a little catch up. All told, Devon has a great balanced portfolio of assets and a lot less debt than Chesapeake but they trade almost double the price to earnings as Chesapeake so on a relative basis they are not as undervalued. Devon stands to benefit if natural gas prices explode, they probably don’t have as much upside as some of the more pure plays out there.
With Chesapeake being too much of a wild card and Devon focused more on oil and liquids, investors need to drill a little deeper to find a winner if gas prices flare up. Two other companies I am starting to watch are Ultra Petroleum (NYSE: UPL) and Southwestern Energy (NYSE: SWN) which are two of the lowest cost producers of natural gas giving them a competitive advantage over their peers. They are both exceptional capital allocators and hedgers which allows them to produce gas cheaper and sell it for higher than other producers. Ultra looks cheaper on a relative basis but I want to dig deeper into both companies in future articles to see if either is worth buying or if going with a basket of natural gas producers would be a better way to invest in the future of natural gas.
There are potentially many winners if natural gas prices explode higher but picking one of those winners is a difficult task. As I reminded us in the beginning, the market can stay irrational longer than any of us can stay solvent. While we have a large supply and demand imbalance that’s currently playing a role in the low natural gas prices, the sky high energy equivalent ratio of oil to gas makes me hopeful that it will quicken the transition to replace oil with cheaper natural gas. Investing in companies like Westport Innovations (NASDAQ: WPRT) who makes natural gas engines for large trucks, can make a good hedge against low gas prices as it should incentivizes companies to make the switch to natural gas as a transportation fuel. Still, I think a turn will come, and when it does I want to be well positioned. Do you have another natural gas producer that should be added to my watchlist?
latimerburned owns share of Westport Innovations . The Motley Fool owns shares of Devon Energy, Ultra Petroleum, and Westport Innovations and has the following options: long JAN 2014 $30.00 calls on Ultra Petroleum, long JAN 2014 $40.00 calls on Ultra Petroleum, and long JAN 2014 $50.00 calls on Ultra Petroleum. Motley Fool newsletter services recommend Ultra Petroleum and Westport Innovations. 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.