DJ Avoid Natural Gas Stocks Except for These 2 Names -- Barrons.com
ByAvi Salzman
Americans use nearly 50% more natural gas than they did 10 years ago, a boom that would be considered a miracle in most industries other than tech. Growth in demand -- helped by power plants abandoning coal -- has continued in recent months, but the price of the commodity is plunging.
Natural gas fell below $2 per million British thermal units on Jan. 21, a level at which most U.S. producers can't make money drilling new wells. Last Monday, prices hit $1.77 per MMBtu, the lowest level since March 2016. A warm winter has sapped demand for gas for heating, while the supply of gas, spurred by the U.S. shale boom, is far outpacing demand.
Absent a ban on hydraulic fracturing, or fracking, in the U.S. -- which multiple Democratic presidential candidates have proposed -- excess supply will probably depress prices for years. That could make most of the industry's stocks poor investments, with exceptions such as Cabot Oil & Gas (ticker: COG), an exploration-and-production company, and Cheniere Energy (LNG), which transports liquefied natural gas, or LNG.
Companies that produce gas are reeling. First Trust Natural Gas (FCG), an exchange-traded fund that holds stocks in the industry, is down 22% this year.
One former reason to buy the stocks -- their healthy dividends -- is disappearing, too. Range Resources (RRC) suspended its payout in January. Shares of Gulfport Energy (GPOR), once one of the largest independent drillers in the U.S., are down 60% this year. The company's 6.375% bonds due in May 2025 are trading at 50 cents on the dollar, for a 23% yield. S&P Global Ratings downgraded the debt of six other producers this month.
Even value investors, who live for half-price deals like this, are steering clear. "I just don't see this industry coming back into balance for the next five years," says Kevin Holt, a portfolio manager at the energy-heavy Invesco Comstock fund (ACSTX). "That's why we're passing on it. If they can't come back into balance, then these companies can't generate enough cash flow to buy back stock and do the things that are attractive to a value investor."
Holt thinks the price of natural gas would have to climb above $3.50 for an extended period for an investment in the stocks to make sense. That might not happen for a long time.
S&P lowered its price outlook in December for gas sold at Henry Hub, a Louisiana pipeline, to $2.25 in 2020, $2.50 in 2021, and $2.75 for 2022 and beyond.
"The risk that prices will go much lower continues to increase, more than people anticipate," says Andy Weissman, CEO of EBW AnalyticsGroup. Weissman thinks that gas could even fall below $1, depending "in substantial part" on weather trends.
Even if temperatures plunge, however, the fracking boom could hamper a rebound in prices. Oil drilling in the Permian Basin of Texas and New Mexico creates so much associated gas that producers sometimes burn it off instead of gathering and selling it. From November 2018 to November 2019, production grew by about 8%, based on the latest government data. That has left the U.S. with 40% more gas in storage than average at a time when seasonal demand typically peaks, notes Cowen analyst David Deckelbaum.
Industries from power plants to steel-making to chemical and fertilizer production use a lot of gas, but still aren't buying enough to move the needle on the price. Natural gas passed coal as the leading source of electricity generation in 2016, and has continued to gain since. But Weissman thinks the move from coal to gas is slowing due to the difficulty of switching some plants over to new generation sources.
Another expected catalyst for gas prices has also come up short. A 2015 law allowing U.S. oil to be shipped overseas opened up major export markets for U.S. LNG, which is a superchilled, highly compressed product. The U.S. now sends about 10% of the natural gas that's produced here to other countries. But demand for more LNG is starting to dry up, with ships full of it now sitting idle, waiting for customers, Weissman says. LNG sold for about $10 per MMBtu as recently as 2015, but fell to record lows of $3 this month, according to S&P Global Platts.
Chinese energy company Cnooc (CEO) reportedly declared force majeure on LNG contracts this month, meaning it no longer will honor commitments to buy and pay for LNG due to forces beyond its control -- in this case, coronavirus.
"Until you arrest those problems, particularly around the supply side, I think it's difficult to put a bid in for the equities," says Cowen's Deckelbaum. "The best way to position is to be with names that can win in a war of attrition."
Deckelbaum favors Houston-based Cabot, whose shares have fallen 14%, to $15, this year. Even at $2 for gas sold at Henry Hub, Cabot can generate free cash, and it still pays a dividend, yielding 2.7%. "They probably have the most unlevered balance sheet within natural-gas equities, lowest cost structure, lowest break-evens," he says. "They can outlast anybody in the space."
Cheniere, also based in Houston, processes natural gas for shipping at a state-of-the-art facility in Corpus Christi, Texas. The company profits by acting as a middleman between U.S. producers and Chinese consumers. Once the spread of coronavirus slows and Asia reopens to energy trading, Cheniere's operations should rebound, along with its stock, which is down 10% since the start of the year, to $55. "To the extent U.S. prices are low, it's easier for them to negotiate long-term contracts with China," says Jay Hatfield, manager of the InfraCap MLP ETF.
As with a fracking ban, a longer-term U.S.-China trade deal that forces China to buy U.S. energy could change the equation. But both developments are long shots, leaving most natural-gas stocks in investment purgatory.
Write to Avi Salzman at avi.salzman@barrons.com
(END) Dow Jones Newswires
February 14, 2020 16:13 ET (21:13 GMT)
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