Hugoton Royalty Trust: A Stock for the Natural Gas Contrarian

Only a diehard contrarian could be interested in natural gas with the near-month futures price down 74% from the 52-week high and a supply glut as far as the eye can see, some might say. Pure play, no-debt, no-hedge, buy-recommended Hugoton Royalty Trust (HGT) is down 71% from its high stock price and trades at 58% of its 200-day average in a sure indication of a downtrend, at least looking backwards. It is also trading up 52% from its low price and has 150% appreciation potential to a McDep Ratio of 1.0. With a little patience, investors can make money in the stock again, we believe.

Thumbnail of Natural Gas Industry Dynamics
On the upside, we have to work through the current surplus either with reduced supply or increased demand. Investment in new supply is drying up and will eventually be zero if price stays low. Without new supply, old supply declines. If it doesn’t decline enough this year, it will by next year or whatever it takes. On demand, we believe in economic growth. Economic growth requires energy. No new coal or nuclear plants are likely to be built in this country for a while.

Even if you are more optimistic on coal and nuclear, it will be very expensive and take a long time. Conventional oil has essentially peaked. Alternative energy is vastly overrated and in the end won’t be cheap or quick either. Looked at another way, alternative energy needs higher natural gas price more than natural gas does.

Much of the decline in industrial demand is inventory related. Once inventories are drawn down, chemical plants start running more again and use more natural gas.
LNG may be available cheap for the next few months, but the total amounts are small, like a few percent of world natural gas supply. Moreover, liquefaction plants are hugely expensive and no new ones will be built at today’s LNG price.

Storage of natural gas is a seasonal issue. Once storage is full in November, it doesn’t get fuller than full and the contribution storage can make to winter supply is finite. Then pricing depends on weather and domestic production as well as industrial activity. By next winter, domestic supply will likely be declining and can be increased again only after a time lag.

Meanwhile, new shale gas supply potential is indeed impressive. It is also given to exaggeration. To get the supply requires an equally massive drilling effort. Whenever we undertake large scale expansion of a new energy source as we did with nuclear power in the 1970s, oil sands in the 2000s, LNG in the 2000s, prices rise far above the early economics used to get the trend started. It is good to have a promising new supply source because that adds political justification for higher prices on existing supply.

Originally published on May 1, 2009

Comments

[scfranklin94:]

No need to buy natural gas stocks until September at the earliest. A good portion of the Hugoton field could be shut-in by early October, forcing the value of this royalty trust to it's absolute low - so why buy it now, when there's a 80% chance it will be cheaper in the fall?

May 30 09:48 AM

[mbkelly75:]

Natural Gas is already moving up just this last week. The stocks tend to be about 2 months behind in their dividend payments. I have noticed that the dividends next month on several stocks that I already own are going to be about 10X higher next month than they were this month. When the rest of the world notices the increase in dividends, the stock prices will move up also, so this may be the ideal time to buy - ahead of the rush. With dividends being re-invested, (automatically in my account) this will give you a good boost without any further effort on your part. An added benefit may simply come from the dividends being paid in the Loonie as opposed to the falling Dollar. I have been investing in stocks that pay in a foreign currency and benefiting this way for a while now. All in all - this may just be a great time to invest.

May 30 11:16 AM

[jimboy:]

Thanks for your analysis. I'm thinking about investing in this stock but am put off by one thing - the underlying assets (mainly proven gas reserves) are depleting so that in maybe 10 years there will be nothing left to drill for and thus no capital or income. As a long term investment it seems to me you'd have to earn a very good dividend to compensate for the fact that your underlying capital is disappearing. Have I got that right?

On May 30 11:16 AM mbkelly75 wrote:

> Natural Gas is already moving up just this last week. The stocks
> tend to be about 2 months behind in their dividend payments. I have
> noticed that the dividends next month on several stocks that I already
> own are going to be about 10X higher next month than they were this
> month. When the rest of the world notices the increase in dividends,
> the stock prices will move up also, so this may be the ideal time
> to buy - ahead of the rush. With dividends being re-invested, (automatically
> in my account) this will give you a good boost without any further
> effort on your part. An added benefit may simply come from the dividends
> being paid in the Loonie as opposed to the falling Dollar. I have
> been investing in stocks that pay in a foreign currency and benefiting
> this way for a while now. All in all - this may just be a great time
> to invest.

May 30 12:04 PM

[blu:]

I might be completely wrong, but I have seen misleading reserves vanish into thin air in the past.
In Texas we are seeing these "fantastic" shale gas wells deplete at alarming rates after a couple of years of flush production from the enormous fracs used to open the reservoirs.
I suspect the shale plays are somewhat over-hyped, and reserves are overstated for most. Time will tell.

In the meanwhile nat gas is trading at such low prices I simply can not pass up buying some, as it is much cheaper to buy it, than to drill for it.

May 30 01:58 PM

[H. T. Love:]

On May 30 11:16 AM mbkelly75 wrote:

> Natural Gas is already moving up just this last week. <snip>

The rest of your comments are good, especially the DIP (div reinvest plan) part. But I wanted to raise a flag, just in case I am reading it right.

Be forewarned: I'm new and an amateur art this stuff, so do your own DD.


Using UNG as a proxy, prices are still trending down. The spike in the last two days, May 28/29, are a "head fake" I believe. Reasoning is thus.

1. Since my comments on 5/11 here,

seekingalpha.com/artic...

UNG has indeed dropped. I took profits at just under $17 and am awaiting a good re-entry point.

The up/down volumes the last 6 days has had more volume down than up.

2. The first day of the rise, Thursday 5/28, was an extraordinary event. At 10:30 A.M., 1.74MM shares were traded, while volume leading up to that were in the roughly 40K range, hitting about a quarter million just prior to this trade.

3. Exactly 30 minutes later, 1.44MM shares traded.

4. Both of these trades spiked up big-time and led the stock up the rest of the day.

5. Even considering the higher volume over the recent couple of weeks, the Thursday volume of 48.65MM shares was exceptionally high.

6. Friday, 5/29, closed down on similar volume as Thursday, 49.08MM shares, but again higher down volume than up Thursday.

7. The spike up Thursday bumped off what I believe is resistance at $15.50.

8. Trading below all SMA, 200, 100 and at 20 and 50 day SMA.

9. I don't see support until $13.50 (weak support - $12.80 is what I really look towards - call it $13), which is where it was at when the huge spikes up came on Thursday.

10. It's still near that $15.50 resistance, and I expect that even the rise in oil won't be sufficient to cause a sustained uptrend without other fundamentals improving.

11. Near-term fundamentals are still weak.

12. Prior to Thursday's spike, RSI on the weak side, MFI neutral, MACD trending down. However, A/D and stochastics indicated an upturn might be coming.

13. Regardless of 12 above, since the volume on the downtrend Friday outweighed the volume on the up Thursday and the trades volumes throughout Friday were more "normal distributions" (largest 1 minute volume was .864MM at the open), I give more weight to the downward trend on Friday than the two weak chart up indicators.

Now, having been so bold as to stick my neck out and place my n00b head into the proverbial guillotine, I await my fate at the hands of the more experienced here.

Forgive the over-complication - background in systems where detail and all factors count.

HardToLove

May 30 07:07 PM