Natural Gas a Better Bet Than Crude Oil

The recent energy pullback (correctly predicted on this blog a few weeks ago on 8/24) provides some interesting entry points for long-term energy bulls. Crude oil has dropped from the high 70's to $65 per barrel and natural gas has dropped from $8 to $5 and change.

As I have mentioned previously, for the short to intermediate term, I believe natural gas is a better bet than crude oil. I don't think we are heading back to $50 crude anytime soon, and most of the correction is likely behind us. However, future catalysts bode well for natural gas prices, as well as leading producers such as Chesapeake (CHK) and Anadarko (APC). After recent corrections, those two names trade at less than 9 and 7 times 2007 estimates, respectively.

Why is natural gas attractive down here at around $5.50 per unit? Two reasons that I can see. One, with no major hurricanes yet this season, investors are beginning to price in the best case scenario for natural gas bears, namely that we will have no damaging storms this year. The investing game is all about comparing current expectations with future probabilities. If we do get a big storm or two, natural gas will zoom right back to $8 or $9. Without a storm, the current expectations prove accurate, and prices likely stay the same. All in all, not a lot of downside from current levels in either scenario.

Let's look past hurricane season to factor number two: the winter. Last year we had a very warm winter, which served to limit natural gas heating demand, and quickly brought prices down from elevated levels reached after Hurricane Katrina. Now I'm not a weather forecaster, and even if I was the odds I'd be correct wouldn't be very high, but chances are good that we could have a colder winter this year. Again, it's all about expectations. Current natural gas prices are pricing in moderation with respect to both the remaining hurricane season and winter temperatures. If we get a surprise on either front, or both, there is nice upside to natural gas prices and the leading domestic producers.

CHK vs. APC 1-yr Chart

Full disclosure: I own Chesapeake personally and Anadarko would be my second choice if I needed to pick another name in the group.

Comments

[Sidney Will...:]

Great points. The PE of Anadarko and Chesapeake are appealing. Do not overlook Devon and Williams with higher PEs but turning over every rock to find oil and gas. They are buying up every lease in Oklahoma and Texas. Devon is in the group that struck the big find in the Gulf. Only a major catastrophe such as a bird flu epidemic could reduce the population suddenly to reduce the demand for oil. This is a wild card that disturbs me, but I remain bullish on oil and gas, unless the unthinkable happens.
Crazies in Iran or North Korea could drive oil to $200 per barrel with a nuclear strike on Japan, or in the Persian Gulf, or on Israel.

2006 Sep 17 08:51 PM

[Chad Brand:]

I agree on Devon... probably my favorite of the domestic players who do crude oil as well.

2006 Sep 18 02:46 PM