A rising tide doesn't always lift all boats. The majorstock
indexes are up 10% or more thisyear , but as I recently noted, it
has been a brutal few months for commodities. But at the time, I
saw a small silver lining.
"These are the kinds of commodities you need to keep tracking,
because lower prices counterintuitively set the stage for the
nextbull market in commodities," I wrote, citing iron ore as an
example. However, I overlooked an even more glaring example of
how slumpingcommodity prices can impair production, which leads
to an eventual pricing rebound.
I'm talking about natural gas, which has been on fire in the
Simplyput , in the spring of 2012, few people saw this kind of
Yet the rebound in natural gas shouldn't have come as a total
shock. After all, the number of rigs drilling for natural gas had
fallen sharply throughout the end of 2011 and the first half last
year, as I noted, and we're now seeing the benefits of reduced
The question is: Can the good times last? Yes, they can.
Natural gas prices are likely toconsolidate back toward the $4
per thousand cubic feet (Mcf) level during the seasonally weaker
spring season (when it's neither too hot nor too cold to generate
much demand from utilities). Still, at that price, it's like
manna from heaven for energy drillers.
At $2 per Mcf, most drillers losemoney , and some would be at
risk of defaulting on theirdebt . At $4 per Mcf, these same
drillers can make enough money to generate solidcash flow .
Better still, $4 natural gas still isn't high enough for drillers
to get carried away and sharply boost their production plans.
The key to this rebound is to be sure that output remains
restrained, right at or below the levels of demand. How does the
output picture look? The weekly tally of domestic gas rigs in
service paints a good picture.
A Healthy Rig Count
Source: Baker Hughes
The fact that the rig count is now below 400 is quite
impressive. (I unwisely suggested more than a year ago that the
rig count needed to fall to 725 for the industry to find
equilibrium between supply and demand, which was clearly off the
You know that the falling rig count is having an impact by one
key measure: For several years, the amount of natural gas in
storage depots remained above the five-year average (adjusted
forseasonality ). Well, the figure is now below average, and
Goldman Sachs expects "a further reduction in gas storage vs. the
five-year average over the next six months."
The key takeaway: Barring a sudden spike in the number of
rigs, $4 gas is here to stay.
Sticking With Ultra
Even as natural gas prices have rebounded, industry share prices
haven't moved much. In effect, the crowd still thinks this
rebound is a head fake, so people are waiting for gas prices to
Yet that looks unlikely with the drop in output that has
resulted from the plunging rig count. In a minute, I'llnote some
of the current favorite ideas being bandied about byWall Street
But first, I'd like to remind investors about one of my
colleague Nathan Slaughter's favorite gas plays. Nathan is our
in-house natural resources expert, and when he talks, I listen.
He's written extensively about his favoriteinvestment
opportunities in natural gas, including America's coming natural
gas highway and the timely revival of a decades-old
Back in October, Nathan told StreetAuthority Managing Editor
Bob Bogda that
Ultra Petroleum (
was one of his top picks. "Ultra is extremely efficient with an
"all-in" production cost of $2.88 per Mcf ... (andwill ) pocket
morecash per Mcf than almost any other producer as prices
Despite hisbullish outlook,shares of "Ultra Pete" are actually
lower than they were when Bob and Nathan chatted about the
company seven months ago. Yet his assessment of the company still
appears to be on the mark.
Assuming that gas prices stay at $4 per Mcf, then Ultra
appears to be on the cusp of a solid upturn in operating cash
flow. Citigroup's analysts see operating cash flow rising nearly
96% to $900 million by 2015.
If gas prices remain stable or even rise, then Ultra will have
a chance to sell its prodigious projected output at locked-in
prices, ensuring those cash flow targets will be met.
Wall Street's Favorite Plays
It seems as if every Wall Street firm has its own favorite way to
play the rebound in natural gas.
- Goldman Sachs is partial to
Bill Barrett Resources (
, citing a new management team that is focusing on much better
cost controls and higher cash flow.
- Goldman also is high on
Southwestern Energy (
, which is sitting on some of the most productive areas of the
Cabot Oil & Gas (
is a favorite of both Merrill Lynch (due to sharply rising
estimates of proven recoverable reserves) and Citigroup (thanks
to projected cumulativefree cash flow of $1.5 billion from now
Risks to Consider:
If the subpar temperatures last winter lead to a
cooler-than-normal early summer, then gas demand might slump, so
keep an eye on long-term weather forecasts if you own any names
in this sector.
Action to Take -->
Any commodity that doubles in value in just a year would seem to
be ripe for a pullback. But the supply and demand fundamentals in
the gas patch are markedly better than they were a year ago. More
importantly, so many industry players were burned over the past
few years by drilling for too much gas that they now understand
the importance of restraining theircapital budgets.
While gas prices may not move up sharply from here, they are
unlikely to fall back, and at current levels, that creates much
more favorableeconomics for gas producers. If you fret that you
missed that rally in gas prices, know that there are still ample
opportunities with gas producers, as their shares have yet to
respond to the commodity's price recovery.