Take Advantage of the Biggest Trend in the U.S

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

Only a decade ago, there was a widespread belief that oil and natural-gas resources were in permanent decline. The opponents of this idea believed that these natural resources will soon become scare. They feared that their prices would rise exponentially as a result of this scarcity. Because of this fear, investors and corporations spent an unprecedented amount of capital seeking out and producing new hydrocarbons. Today, those investments are bearing out to a degree almost no one could have imagined. This wave of investment began in 2003. It peaked in 2010 and 2011, when more than $1 trillion annually was spent around the world on oil and natural-gas exploration and production.

In 2011, as a result of this massive capital investment, the U.S. produced the most natural gas in history. The previous peak was in 1971. Over the past four years, gas production is up 20%. With all the new supply coming online, the price of gas crashed. From June 2011 to April 2012, it fell 63%. Then, when no one thought natural gas prices could go anywhere but down, the opposite happened. Prices began to rise. Since April 2012, natural gas prices have been in a strong uptrend, rising 114% in just 14 months.

The opportunity

There's a certain anomaly waiting to be exploited. While gas prices have more than doubled, the share prices of gas companies have gone nowhere. Just 12 months ago, these companies were pulling gas out of the ground and selling it for $2 per thousand cubic feet (mcf). Today, the going price is nearly $4 per mcf. In just over a year, gas prices have doubled. Yet, the prices of companies that pull gas out of the ground and sell it are up just 5%. Higher gas prices should mean higher earnings. And that should translate to higher share prices for natural gas companies. But that hasn't happened yet.

How to take advantage of this opportunity

I believe the best way to take advantage of this opportunity is to invest directly in shares of gas companies. There's an abundance of gas companies, but there're only a handful of high-quality companies with strong management in place, and with a constant focus on the shareholder. Below are my top three gas companies.

  1. Chesapeake Energy (NYSE: CHK) is a $13 billion oil & gas company in the U.S. Chesapeake was in the news several times in the past year after activist investor Carl Icahn bought a large stake in the company and kicked out the famously frivolous CEO, Aubrey McClendon. Chesapeake is now much more shareholder-oriented and is working to resolve its debt issues. The company is very efficient with its drilling. It spends $2.2 per mcf while the industry average stands at roughly $3. I believe that WPX could be a great turnaround story after its shares have lagged the S&P 500 by more than 10% in the past 12 months. 
  2. WPX Energy (NYSE: WPX) is a relatively small $4 billion company. I like WPX for two reasons. First, it's the most economical company in the industry. It only spends a total of $1.48 per mcf to find and develop a natural gas well. That's half of the industry's standard. Second, it's highly conservative. Unlike Chesapeake, with its mountains of debt, WPX currently maintains $1.5 billion of cash (50% of its total market cap) on its balance sheet and trades at less than 75% of book value. It's now dirt cheap.
  3. Quicksilver Resources (NYSE: KWK) is a small $300 million gas company. Recently, the company announced the sale of a 25% interest in Barnett Shale assets to TG Barnett Resources LP, a subsidiary of Tokyo Gas. This will relieve the company of part of its massive $2 billion load of debt. As of now, the company is cheap and trades at only 0.7 times annual revenues. I believe that given the significant reduction in debt as a result of this deal, there is plenty of upside for the equity part of the business, thereby offering upside for shareholders.

My Foolish Take

Gas prices have strongly rebounded, but shares of gas companies haven't. It doesn't take a genius to realize that with higher gas prices, gas companies will make more money, and become more profitable. But the market doesn't realize that now. By investing in shares of gas companies, you are effectively exploiting this anomaly. Invest accordingly. 

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Shmulik Karpf has no position in any stocks mentioned. The Motley Fool has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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