Introducing the complete natural gas company makeover
Look beyond doom and gloom for long-reserve life, liquids-rich buying opportunities
If the CBC was to produce a new reality television show on the oil patch, I can think of no better concept than “Extreme Natural Gas Company Makeover.”
The show would highlight the actions being taken by junior and mid-cap natural gas companies that are doing whatever is required to shun the image of being a dry natural gas company, an attribute that has now become the modern day equivalent of having leprosy. Sentiment today towards natural gas stocks is the worst it has been in many years, and this mood is setting up a tremendously profitable investment opportunity.
The move to shift away from natural gas first started well over a year ago when it became obvious that shale gas, held-by-production drilling, in-the-money hedge books, joint ventures, and liquids-rich natural gas drilling were all resulting in a flood of excess natural gas supply.
Some forward looking companies like Monterey Exploration managed to find suitors at very significant premiums, while others decided to try to wait it out. Time passed and the window of being able to get large takeover premiums closed. Companies then began to try to convince investors that they weren’t really natural gas producers after all given their breakdown of revenue and not production. (The lower gas went, the more of an oil/liquids company they became.)
Denial eventually turned into despair. Galleon Energy Inc., Orleans Energy Ltd., Cequence Energy Ltd., and NuVista Energy Ltd. experienced management turnovers in an attempt by their boards to signal the unwillingness to accept what had become the status quo. Then there were those who showed ingenuity. Open Range Energy Corp., for example, made an incredible transformation from a natural gas company with a unique idea of storing frack water to a billion-dollar market cap service firm with a side natural gas business within one year.
Others, like Vero Energy, recognized that new action was required to derive a different result – namely the unfair recognition of their impressive production per share growth. Its response was to sell nearly all of its natural gas for a very respectable valuation, transforming into an oily Cardium-focused producer and regaining investors’ interest. All of these actions were for the purpose of wooing investor’s attention, and they all demonstrate the apathy towards the space currently.
This sentiment is not without justification. We’ve had one of the warmest winters in the past 60 years, resulting in record-low heating demand. Production continues to set a new record every month due to the incremental revenue bump from associated liquids. Carbon dioxide legislation that was meant to increase demand by several billion cubic feet per day has been stalled due to political gridlock. The outlook in the short- to medium-term is less than fantastic.
It is this very doom and gloom, however, that could possibly lead to the trade of the year. At some point in 2012, we could have a decoupling between the price of natural gas and the price of natural gas stocks. That means that spot natural gas prices may go down due to bloated storage, but the price of natural gas stocks will likely have bottomed. That sets up a significant rally in the future.
Indiscriminate selling has already created several attractive entry points, and with the possibility of further weakness in gas names, valuations will become even more attractive for anyone with at least a medium term investment time horizon. Look for capitulation to signal for the first time in several years that it is finally time to buy natural gas stocks. When will we know we’re seeing capitulation? Watch for large blocks going up at discount prices while at the same time brokers are issuing comp tables with $2 natural gas 2013 forecasts. It will be at that time when we are at the point of maximum pessimism, and when a medium- to longer-term horizon will likely be greatly rewarded for going against the herd.
While a recovery for the price of natural gas is unlikely until Canada becomes an exporter via West Coast liquefied natural gas, buying low-cost, long reserve life, liquids-rich natural gas when it is on sale will make money, even if one has to be patient enough to wait for the (hopefully) cold weather to return in the fall.Related