Natural Gas Weighted Companies: Is It Time To Take A Look?
We would suggest that perhaps it is time to consider adding natural gas weighting companies to one's portfolios. We have put a list of 10 Companies that offer the potential to outperform, if we are correct on our macro market call for NATURAL GAS PRICES GOING HIGHER! Our attention was on the smaller to intermediate group of selected Canadian Oil and Gas Companies.
Among them, we have included two special situations: Thunderbird Energy Corporation (TSX-V: TBD) and Corridor Resources Inc. (TSX: CDH) that, in our opinion, offer tremendous leverage as a result of their large natural gas resource plays in relation to their very modest capitalization of $12 and $75 million, respectively.
There are three main reasons why we think natural gas prices and therefore natural gas companies are poised to outperform in the next 6 to 12months.
- Natural Gas Consumption in the United States is not only growing but it appears that it is about to become an acceptable alternative transportation fuel for the American market.
- Share prices of these Companies are not only at or near 52 week lows but in some cases at multi-year lows and are trading at less than 50% of Net Asset Value (NAV).
- Canadian oil and gas companies are clearly attractive acquisition candidates for an energy thirsty world and the natural gas producers are the most undervalued.
Natural gas prices appear to have bottomed in North America due to growing demand and reduced drilling of natural gas wells. Hotter than normal temperatures across the U.S. in June and July, raised demand from gas-fired power plants, as homes and businesses cranked up air conditioning. The warm weather contributed to a sharp slowdown in the growth of U.S. gas inventories, leading to a rally in natural gas that pushed prices to seven-month highs in mid-July.
Demand for natural gas is showing renewed growth in the United States and, we believe, it will be more robust than many have assumed - the trend is your friend - and natural gas prices are trending higher.
In July, the U.S. Energy Information Administration (EIA) reported that U.S. natural gas consumption will average 70.2 billion cubic feet per day (Bcf/d) in 2012, an increase of 3.4 Bcf/d (5.1 percent) from 2011, and an upward revision of 0.6 Bcf/d from last month.
Projected consumption of natural gas in the electric power sector is expected to grow by almost 21 percent in 2012. Estimated growth in gas consumption will be primarily driven by the relative cost advantage of natural gas over coal, for power generation in some regions. For the first time, the US today is generating a third of its electricity from both natural gas fired thermal plants and those using coal. As a rule of thumb, the $3 to $3.50 per mcf price for natural gas is considered an equilibrium point for switching between the two. In addition, the EPA announced in March'12, that carbon emissions standards for all new coal-fired electricity plants will force many power companies to back away from coal. Also new natural gas electrical power plants are at least 50% more efficient than new coal fired plants.
At current natural gas prices of approximately $3.00 per mcf, United States fleet owners see a $1.50 per gallon cost advantage over gasoline or diesel, making Compressed Natural Gas (CNG) a compelling economic fuel option.
What is stunning in a country which has shown historically tremendous ability to adapt, is that the US has less that 1% of the 13 million CNG vehicles operating worldwide - we believe this ratio will be changing rapidly.
There are more than 1,100 NGV fueling stations in the U.S. - and about half of them are open to the public. Construction of an America's Natural Gas Highway with LNG and CNG fueling stations is well underway.
On the Supply Side, US drilling for natural gas has dropped to the lowest level in 13 years, as producers continue to focus on more profitable oil and gas liquids wells. Gas-directed rig count currently stands at 505 as compared to 1,600 in 2008.
Shale gas has provided a bounty that few, if any, have ever expected. Had petroleum industry not cracked the secret of unlocking natural gas from these humdrum rocks, filling most of the sedimentary basins, the United States today would be dependent on expensive imported LNG.
However, it must be stressed that much of the recent gains in natural gas production in various North American shale basins, have come with expensive horizontal drilling and fracking. Also there is little, if any, history to tell us how this shale gas production will stabilize after the initial flush production. Gas production stabilization is an important unknown variable that will impact the supply forecast in the US, especially, in light of significant reduction in drilling of new natural gas wells.
Recent news wire reports point out that BP PLC (BP), EnCana Corp. (ECA), BG Group PLC (BG.LN) and just last week BHP Billiton have combined write-downs totaling more than US$8 billion on their "Shale Gas Investments" as a result of the low U.S. gas prices. These low natural gas prices are not sustainable.
The reduced drilling activity for natural gas is now becoming evident in the US natural gas storage, which although 15% above seasonally adjust five-year average levels, it was 60% higher in March'12. Recent weekly storage injection rates are less than half of five-year averages for mid-summer. Cooler weather will bring reduced air-conditioning needs, a corresponding drop in electrical demand and perhaps a modest tempering natural gas pricing, but we think we have seen the bottom in this cycle.
The share price of these natural gas weighted companies is not only near 12 months lows, but in many cases, at multi-year lows. This is not to suggest that their share prices may not see further decline, but a common sense would suggest that they are trading at a lower end of the risk profile.
Our final argument recommending natural gas stocks is that the Chinese are coming, as well as the Indians, the Malaysian, and the Koreans and we expect in due course, some of the Europeans.
The simple reality is that due to LNG, the natural gas today is a global commodity and in the eyes of these foreign investors, our current market valuations of the natural gas producers are at the ridiculously low levels.
In June 2012, Petronas, the Malaysian state-owned oil company, joined other Asian peers including PetroChina Co., Mitsubishi Corp. and CNOOC Ltd., in seeking production in North America, where natural gas sells for less than 15% of Asian benchmark prices. Petronas' $4.6 billion offer for Progress Energy Resource Corp. in June'12, recently had to be increased by 8% due to an unsolicited counter offer from a third party.
Progress reported in Q1'12 that the natural gas contributed 85% to its total of 47,000 boepd. Yes, Canada's Heavy Oil and Oil Sands do hold a special attraction to large, generally state-owned, oil and gas Companies, but with a growing appeal for LNG, our natural gas assets will attract eager foreign buyer especially, when they can buy them for effectively less than a third of what oil assets fetch.
Why would we make such a statement?
It is simple math that even with a generous 50% premium, the buyer would essentially purchase these companies for $5 to $10 per BOE for 2P Reserves and we just do not see oil assets selling for much below $25 per BOE.
The following table of 10 selected Canadian oil and gas companies is chosen for their production mix with natural gas bias. As noted in the Table, the Debt/Cash Flow Ratios for some of these companies are much higher than most investors have historically found it comforting, due to the reduced cash flow as a result of natural gas prices, and will therefore dissuade many from venturing into owning these stocks.
If we are right on our call for higher natural gas prices, we expect that like a rising tide lifts all boats, all of these Companies will see higher share prices in the future.
Paramount Resources Ltd. is in our opinion, one of the best home grown E&P Company's we have had in Canada, mainly due to the management by Mr. Riddell who holds 43%. Rumors have circulated earlier this year that Petro China has come courting the Company and this probably explains, why the Company has been busy reorganizing its heavy oil assets and other assets, which include almost $8 per POU share of marketable securities. We wish Mr. Riddell and his team all the best and feel confident his tenure at Paramount will be well rewarded in time.
Birchcliff Energy Ltd. is not timely, we believe, for the day trader, but with its current share price near a 4 year low, why not follow the track of Mr. Seymour Schulich one of Canada's most astute investors who holds 26% of the Company. For comparison, Birchcliff is about half the size of Progress Energy which, as we noted, is in the process of being purchased for $5 billion -Birchcliff is trading at just over $1B!
Crew Energy Inc. just made our natural gas list but to be technically correct, the Company is more an oil producer with natural gas accounting for only 45% of production mix. Decent balance sheet, trading at half of NAV and at less than 4X our 2012 cash flow, makes Crew Energy good candidate to speculate on our natural gas price outlook. The 10-year chart has shown BIG SHARE PRICE SWINGS!
NuVisita Energy Ltd. has been recognized as one of the better managed Company's but with 70% of its production in the form of natural gas, the last four years have not been a pleasant experience for the Company's shareholder's, with shares trading at near a 10-year low range and at less than a quarter of high in 2009. Ontario Teacher's Pension with 18% and Franklin Templeton with 16% ownership, have shown prudent successful money management in the past and it would not be unreasonable to assume they have made a sound investment with NuVista. To buy or not to buy - that is the question which depends on what happens to natural gas prices.
Guide Energy Ltd. is trading at close to a 10-year low, even with the management team shakeup almost one year ago when Bill Andrew of Penn West Petroleum fame brought his team to run the company, and then called Galleon Energy. Trading at third of our calculated NAV, it may be a reasonable hunch that this new management team may choose to toss-in-the-towel and look for merger candidate.
Lone Pine Resources Inc., based on our analysis, trades at less than 1/5 of our calculated net asset value and 17% of its Initial Public Offering. The total amount of debt is certainly troublesome and will need to be addressed. Prior to the IPO on June 1, 2011, Lone Pine Resources was a wholly owned subsidiary of Forest Oil Corporation. On September 30, 2011, Forest distributed to its stockholders all of the shares of common stock of Lone Pine it owned, which probably explains the dismal share price. Lone Pine may make for a very good buy now!
Perpetual Energy Inc. in its previous form as an energy trust exemplified a very successful Canadian natural gas company. We believe that the seasoned management will once again achieve the valuations that will make it hard not to be pleased if you are a shareholder.
Pace Oil & Gas Ltd. in early July'12 adopted a shareholder's rights plan to ensure that any unsolicited takeover bid could allow the Company an opportunity to maximize value for its shareholders even if Pace Oil & Gas is not aware of any such pending or contemplated proposals. We certainly consider this a prudent and appropriate move with the current shares trading at less than 3X this year's cash flow.
Corridor Resources Inc. holds a shale gas resource evaluated by credible independent third party of a staggering 67 TCF. What we find especially stunning is that this resource is located a mere 100 kilometers from North America's newest LNG Facility in Canaport, New Brunswick. One wonders how long will it take for Repsol, the LNG Terminal Owner, or some other knowledgeable player to seize this gem as an opportunity to turn this money losing, Canaport LNG Import Facility into an Export Facility. Unlike the challenges facing those who want to move LNG from the Canadian west coast to world markets, Corridor's resource needs no new trans-provincial pipeline, lengthy environment approval or the First Nation Agreement.
Thunderbird Energy Corp. has just commenced the eight-well fracking program which has the potential to triple the Company's already impressive 2P Reserves valued at $0.70. If we are right that Natural Gas, the ugly duckling is about to become a beautiful swan, this penny gas stock could prove to be a pure gold.
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