As the Obama administration gets set to spell out the
restrictions placed on offshore drilling, one thing is clear: The
domestic supply of oil and natural gas is bound to be cut -- at
least in the near-term. This should have little impact on oil
prices, as the commodity is global in nature, and the Gulf
contributes only a tiny fraction of the world's output.
Natural gas -- that's a different story. It's not a fungible
commodity. Natural gas costs more to transport from distant lands
and the Gulf accounts for about 12% of all domestic gas production.
That means the market for natural gas, which has recently had
greater supply than demand, could come into balance.
If that happens, the folks digging for gas on dry land would
finally have a reason to cheer. Land-based drillers were euphoric a
few years ago when they discovered that the United States was
sitting on massive pockets of underground gas that could now be
tapped thanks to new technology. The euphoria was short-lived as it
quickly became apparent there was perhaps too much gas yet to be
tapped. Prices fell off a cliff, and have remained at multi-year
lows ever since.
Share prices of most land-based drillers now sit well off of their
highs from a few years ago. But all that's about to change.
Since last Wednesday, natural gas prices have risen from $4.25 per
MCF (thousand cubic feet of gas) to $4.86. Once prices breach the
$5 mark, analysts expect prices to move toward the $6 level as
demand for natural gas is set to rise when power plants crank out
more juice to satisfy air-conditioning needs. At that price, we'll
start to see sharp upward revisions to profit forecasts for many
firms in this sector.
Three Ways to Play
The potential earnings power of
Chesapeake Energy (
highlights the extreme impact that natural gas prices can have.
Analysts at Morningstar believe if natural gas prices were stuck
around $5 per MCF, then its stock is worth just $7, well below the
current price. But if prices rose up to $15 per MCF (they hit
almost $14 two summers ago), then shares would be worth a whopping
$80. More than likely, natural gas prices will fall between those
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For Chesapeake, which carries a lot of debt and has had to bring in
myriad partners to help fund all of its operations, this level of
volatility is especially pronounced. If you are bullish on natural
gas prices and believe that an eventual economic rebound will push
energy prices sharply higher, then Chesapeake likely has the
greatest price appreciation potential of any of the natural gas
Less Risk but Still Has Rewards
If you don't want to swing for the fences with a stock like
Chesapeake Energy, you may want to check out
Range Resources (
, which owns prime real estate in a newly-developed region in
Appalachia known as the Marcellus Shale. Range Resources is tapping
this shale with more than 100 wells, and output is expected to
climb steadily in coming quarters.
The key is tying that output to expected natural gas prices.
Roughly speaking, every $1 move in natural gas would impact Range's
value by around $10 a share. Assuming natural gas prices rise to $6
per MCF during the next year (as futures contracts indicate),
Range's gas fields are likely worth about $65 a share. If gas fell
back to around $4, then shares are likely worth about $45, roughly
-10% below current levels. But in the event that natural gas prices
rise to $9 -- halfway between the low and high prices seen in the
last two years -- shares would be worth about $95 a share, nearly
double the current price.
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It would take robust global economic growth to push energy prices
back up by a healthy margin , and few are expecting that in the
next 12 to 18 months. But with share prices reflecting the worst
case scenario on natural gas, the reward here looks quite good for
the risk investors are being asked to assume.
Nabors Provides the Tools
If natural gas prices only moderately rise, it might limit the
upside of these gas producers, but should be sufficient to push the
number of working gas rigs ever higher. The natural gas rig count
bottomed out less than a year ago, and is now rising virtually
every week. Trouble is, the industry built too many rigs when
business was booming and many are sitting idle. This is pushing
down the lease rates that major vendors can procure.
The good news is rig suppliers aren't building new ones, and as
more rigs get put back into service, lease rates are rising. This
should help boost results for
Nabors Industries (
, the industry's largest player.
Shares have recently held appeal for value investors, as the
company's $18 a share book value provided value for bottom-fishers.
Now, growth investors are rotating into the shareholder base. Sales
should be roughly flat this year, but could rise about +15% next
year, thanks to a combination of rising lease rates and more rigs
in service. This should propel earnings growth of more than +50% in
2011 to about $1.65.
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As a point of reference, Nabors earned about $3 a share in both
2006 and 2007. Assuming this drilling cycle is not as robust as the
last, figure per share profits rise to about $2.50 by 2013. If
shares trade at roughly 12 times that figure, they'd rise to about
$30 -- or more than +50% above current levels.
-- David Sterman
Disclosure: David Sterman does not own shares of any security
mentioned in this article.