As Natural Gas Inventories Plunge, Investors Should Buy Oil Service Stocks

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Based on the limited positive reaction of natural gas and coal stocks, the market continues to ignore the very bullish natural gas weekly inventory reports. In fact, the reports are now mostly glazed over in the financial media.

For those that missed the report last week, the weekly inventories for the first full week of April dropped 14 Bcf. While less than the 21 Bcf expected drop, the small decline is actually significant as the inventory level over the last 5 years has typically made gains. Normally this time of the year the inventories flat line and even gain during the transition season from the heavy usage in the winter to the heavy drilling in the summer.

As mentioned in the previous article on coal stocks, the amount of rigs drilling for natural gas is at historically low levels right at the time the numbers should be ramping up. Even worse, the desire to drill for natural gas is also compromised, as oil is more profitable at the current levels. This combination will ultimately lead to an increase in demand for oil services and hence the stocks that have lagged for a while.

Plunging natural gas inventories

The weekly natural gas inventories dropped 14 Bcf compared to the normal seasonal gain causing the 5-year average to quickly move further into a deficit. The turning point around March of each year can have a very wide range. The range has been nearly double from top to bottom with last year having 2,477 Bcf in storage and the low point in the previous years at nearly 1,200 Bcf. The scary part is that the inventory levels were at the highest levels in that span back around the peak in October 2012 and within one winter season the inventory levels are now below average and plunging.

As the chart below shows, the current level of 1,673 Bcf is now 3.8% below the average though only three weeks ago the current inventory levels were 9.5% above the average.

<img alt="" src="http://g.fool.com/editorial/images/33483/screen-shot-2013-04-17-at-102539-am_large.png" />

Under the radar oil service stocks

Investors can use this data to go several directions from investing in oil service providers to drillers to exploration to coal minors. As mentioned in the last article, the coal stocks have been the most devastated group, but the oil service firms haven’t benefited as much from the growth in shale advances as most would think. In general, investors can probably invest in the group and make comparable returns from the group. The most intriguing under the radar stocks are the following:

C&J Energy Services (NYSE: CJES) – the hydraulic fracturing services sector is very fragmented, but this company is a leading independent provider. C&J Energy now has a market cap below $1 billion and a revenue base of over $1.2 billion. The company is also very profitable having earned $3.76 in 2012 with forecasts of making nearly $3.00 each of the next two years.

The stock has consistently traded in the $20 range after dropping from a peak over $30 around when the stock went public back in the summer of 2011. With the stock currently trading at the low end of the range, investors can scoop it up as sentiment is negative.

Heckmann Corporation (NYSE: NES) – the company recently completed a merger with Power Fuels to create the leading environmental services provider in the energy sector. Heckmann has a market cap of around $1 billion with a revenue base approaching $800 million. The company is changing its name to Nuverra Envrionmental Solutions to better create a brand around the focus of the company.

The merger expanded the firm into the Bakken shale and now allows it to become a solution provider in all of the leading shale areas. The stock currently trades below $4 and has flat lined in that area since the merger with Power Fuels greatly improved the profitability of the firm.

U.S. Silica Holdings (NYSE: SLCA) – unlike the other oil service stocks, U.S. Silica has been on a tear of lately. The stock trades closer to 52-week highs at around $21 after spending some time below $10 in the summer last year.

The company has a revenue base of around $550 million with a market cap of over $1.1 billion. It produces the commercial silica used as the sand in the fracturing process along with hundreds of other uses.

Stock Performance

The stock performance of the sector has been horrendous since the start of 2011. The group mentioned above has greatly underperformed the PHLX Oil Service Sector Index during that period.

<img alt="" src="http://media.ycharts.com/charts/26b73a09f3e46079e846e08bd91e65aa.png" />

CJES data by YCharts

Note that U.S. Silica went public during the period.

Bottom line

The combination of natural gas inventories plunging to below average levels and decade lows in rigs directed at natural gas drilling sets up the perfect storm for a rebound in demand for oil services needed to increase drilling.

The above oil service stocks are mostly down over the last year or so. While the stocks don’t provide the same snap back potential as the coal stocks, each has the potential to generate solid gains over the next few years as demand rebounds. In addition, all now operate very profitable business providing downside protection not provided in the general coal sector.


Mark Holder and Stone Fox Capital Advisors, LLC own shares of C&J; Energy Services and Heckmann. The Motley Fool owns shares of Heckmann and U S SILICA HLDGS INC COM USD0.01 and has the following options: Long Jan 2014 $4 Calls on Heckmann and Short Jan 2014 $3 Puts on Heckmann. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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