The Best Natural Gas Stock
Natural gas is almost a dirty word. After hitting an all-time high almost five years ago north of $15 per MMbtu or (million British Thermal Units), natural gas prices have been confined to bear market territory. At just $3.92 per MMbtu now, many producers will either go bankrupt, become buyout targets or struggle to earn a decent profit for the next several years…unless prices rally soon.
Almost no one likes natural gas. Supplies are abundant, companies’ profit margins have atrophied, if not disappeared altogether, and most analysts think gas prices will remain low for a very long time. The advent of Canadian and American shale gas production has put another big dent in prices…and bullish sentiment.
But one company dominates profitability in North America. Not only is this company generating piles of free-cash from shrewd forward hedging, it is also entering potentially lucrative joint-ventures to boost production. Despite these virtues, this company’s stock trades 30% below its all-time high, and only slightly above book value. The company I’m talking about is Canada’s EnCana Corporation (NYSE:ECA).
But before delving into the bull case for EnCana, let’s explore why natural gas prices have remained so depressed and what developments might lead to a reversal of fortune.
There’s no denying that there are good reasons for the slumping price of natural gas. Supplies are ample. Storage facilities across North America are still swelling amid rising supplies. Winter 2010 ranked among the warmest in history with March temperatures alone hitting the record books – March was the warmest in the Northeast since 1946. Unseasonal temperatures don’t help gas prices. If temperatures are above-average in any given winter then households and businesses consume less natural gas.
Ironically, if above average temperatures continue into that summer months, that would be bullish for natural gas. The hotter the weather, the greater the use of air conditioning – a factor that increases electricity usage and therefore, natural gas usage. Also, the Gulf of Mexico, a major hurricane corridor, has been unusually calm since Hurricane Katrina in 2005. That might change this year.
Oil has been a far more consistent performer in the energy sector than natural gas. While crude oil has more than doubled off its post-credit-crisis lows, natural gas prices remain depressed. Despite their recovery off ultra-low levels last summer, natural gas prices are still more than 70% below their record highs.
But the bear market in natural gas will end, simply because very few producers can produce a profit at current prices. Many producers are suffering large losses. But this condition will not last forever. In fact, it may be changing already. Several factors suggest gas prices will rise back above $6, possibly $7 over the next 12-18 months.
For starters, the crude oil-to-natural gas ratio hit a multi-decade high last summer, and remains near that level. In other words, natural gas is extremely cheap relative to oil. This ratio is signaling we are at extreme lows in natural gas prices – a solid “buy” signal.
Another bullish indicator is Exxon-Mobil’s (NYSE:XOM) recent takeover of natural gas producer, XTO Energy (NYSE:XTO) for $41 billion dollars. Exxon-Mobil is the world’s largest company by stock market-capitalization and easily the biggest in the energy sector. Exxon knows something more than nothing about natural gas. Obviously, Exxon-Mobil would not write a $41 billion check for a natural gas company if it believed natural gas prices would be languishing for the next several years. Clearly, Exxon-Mobil believes natural gas prices are at an extreme low.
Finally, natural gas is the cleanest-burning fossil fuel, unlike oil or coal. As the United States, China and other countries look to shrink their environmental impact, gas has the edge over oil and coal because of its cleaner-burning properties. And coal, which remains highly popular and generates 50% of electricity in the United States, is also the culprit responsible for 81% of the carbon emissions spewing into the atmosphere. Natural gas is by far the cleanest burning fossil fuel, while also emitting half the carbon dioxide of coal. These facts alone are powerful drivers of natural gas consumption and they won’t change.
As natural gas prices eventually form a secular bottom in this cycle, the ensuing bull market promises to be lengthy and robust. EnCana offers a great way to participate. Based in Calgary, Alberta, EnCana is North America’s largest and most profitable natural gas concern. Management is superb. President and CEO, Randy Eresman, has been the driving force behind the company with 25 years of experience at EnCana and has a first-class executive team and board to steer the gas giant.
In 2009, the company spun-off its oil sands business as Cenovus Energy went public, generating about $3.5 billion dollars for EnCana. Following the spin-off, EnCana is now a pure natural gas story. The company’s shale gas properties are the muscle behind EnCana’s goal to become the world’s dominant player. The company is actively developing these reserves, both independently and through various joint ventures.
EnCana was an early pioneer in the shales. And today, the company’s core business is unconventional natural gas with its main holdings in the Haynesville shale, Deep Bossier, the Rockies, Horn River Basin and the Montney shale. EnCana produced daily production volumes of approximately 3 billion cubic feet of natural gas equivalent in 2009 with 95% weighted to natural gas.
The company’s balance-sheet strength is considerable. Long-term debt is now being reduced, following the cash proceeds from the Cenovus spin-off. Even before the spin-off, EnCana held relatively little debt. Another plus for EnCana shareholders is that – unlike many other energy companies that continue to struggle with a decline in long-term production – EnCana has no major resource play currently on terminal decline. In fact, the company has several great properties with high revenue potential.
EnCana continues to generate positive earnings in a tough environment, sports a healthy dividend of 2.5% and trades just above book value. So why not buy now and wait for the inevitable turnaround in gas prices?