Cooper: Turnaround Coming for Natural Gas

Robert Cooper joined Acumen Capital Finance Partner in August 2008 as an Oil & Gas Analyst. Prior to joining Acumen, Robert spent several years in equity research with two other investment banking firms covering the junior oil and gas industry, in addition to several years with a leading mid-market merchant banking firm. Prior to that, he spent two years with a leading commodity trading organization as a commodity trader. Robert has a finance degree from the University of Regina, is a CFA charterholder and is Vice President of the Calgary CFA Society.

Q: Given the widespread pessimism regarding natural gas and the glut in inventory, what are your thoughts going forward for this commodity?

A: The night is always darkest before dawn and I think in early September we reached dawn with gas bottoming out at cyclical lows. I tend to be a contrarian by nature so when everyone is stampeding for the exit I take note of it but try to find out what is driving the group-think. Low prices for natural gas have been driven by two things: First, the rapid deterioration in U.S. industrial demand and, second, supply increases primarily driven by the U.S. shale plays (i.e. Haynesville, Marcellus, et al).

With the massive stimulus percolating through the U.S. economy, I think there is a chance that industrial demand will perk up as the U.S. economy gathers steam. Generally, the best cure for low prices are low prices. Drilling levels have been way down and this will inevitably lead to a supply response. So overall, I think we could see upside from here although in the short term gas will be highly correlated to the amount of cold weather that hits the major consuming regions in the U.S. Longer term, policymakers are eventually going to realize that natural gas should be the preferred fuel type going forward -- it is plentiful, cheap, clean and doesn't involve sending billions of dollars overseas to questionable regimes who produce oil.

Q: With crude oil hovering at approximately $80/barrel, do you think these price levels are sustainable for the next 1-2 years, especially in light of the IEA saying that they only expect a marginal increases of 1.5% per annum in oil demand between 2007 and 2030 in their most recent world energy outlook, why or why not?

A: Generally, yes I agree. Oil appears to be trading at or about the marginal cost of new supply. We have seen comments coming from some of the supermajors, for instance, that for new oil sands projects to proceed an oil price of around $80/bbl is required in order to earn an appropriate rate of return. What folks fail to appreciate sometimes is that the world is awash in expensive sources of oil. The easy to produce oil has been produced. Therefore, in order to stimulate new supply, prices have to be strong and remain strong. Extreme volatility doesn't do anybody any good -- it adds risk to major projects on the corporate side and wreaks havoc on the demand side (consumers). What I will say, however, is that oil is now much more dependent on emerging market economic growth than OECD growth and that is a big shift from years past.

Q: With the oil/gas ratio sitting at approximately 20 and the average over the last 2 years being around the 12 to 13 mark, would you short oil at the moment or go long natural gas?

A: I like the risk reward profile of natural gas better at the moment but that doesn't mean i would short oil. It takes a brave soul to short oil when you are one terrorist attack or geopolitical event away from a steep change in price. Some smarter folks than I may do that but I prefer to sleep at night.

Q: What is your outlook for M&A activity in the energy sector? Do you have any plays (as in the bakken, montney, cardium etc.) or particular stocks that may be particularly susceptible to M&A activity?

A: The short answer to that question is that I want to own energy stocks that larger energy companies want to own. And, in my opinion, larger companies want to own assets in which they have a high degree of working interest, have low operating costs through controlled infrastructure/facilities and assets that have scale and scope (through increased capital intensity, improvements in technology, etc.) Finding names with those attributes can often lead to potential M&A targets. I try to find these companies and own them because they are good investments that may get merged out, not solely because they are M&A targets.

Q: Lastly, can you please highlight one stock/theme that you think offers the best value moving forward and your reasons for liking it?

A: I don't have a specific stock pick but I like resource plays. That speaks to the scale and scope point I made earlier. Repeatability of a specific play type is very important and is worth more to investors because it is predictable. As a general rule, predictability is usually worth more than unpredictable results.

Comments

[dwprice:]

"Drilling levels have been way down and this will inevitably lead to a supply response."

They have been down, but the wells being completed are generally good wells, so supply has gone higher. The rig to supply dynamic imo has changed with improved completion technology. Supply should stay strong into spring and beyond but prices should improve to $6-$7/thousand. Hopefully, someday our govt will take notice and get behind ng.

Nov 13 01:59 PM

[Ferdinand E...:]

"Oil trading at the marginal cost of new supply". What is the point in making a nutty statement like that?

Nov 14 09:17 AM

[jerrydd:]

I've seen evidence NG is being sold under production costs in most of the NG shale plays which would make them not a good investment. They took the financial statements and compared them to output and production costs were $5-8/mmbtu and now selling for $4/mmbtu by overstating reserves vs actual historical output. Not good!

Other details is the old rigs were dropped because the new ones produced far more NG than the old ones/$. Obviously production has increased.

With the getting stronger El Nino the winter is likely to be warm. Lucky for us in Fla, Gulf it cuts hurricanes too.

Oil sands production costs is close to $30/bbl according to the producers, not $80. But they are limited to what they can produce so not a market mover.

Nov 14 11:12 AM

[jerrydd:]

Report spammers like Ecup and financeopinionss.blogs and others as abuse under the report abuse link and we can drive them away. Don't bother just asking them to stop as they won't.

Nov 14 11:15 AM

[Osterix:]

I am very interested in the Canadian Tar Sands (oil sands) with respect to how they fit into the total US energy picture. I would like to know if you have any additional info or just opinions about the following points: 1) I know that the producers say their cost is about $30 a bbl, but that is oil from existing capital plant. What I have not seen anywhere is what would be the production cost from an expansion project that started from scratch tomorrow. I suspect it would be more than $80 a bbl. 2) Aside from the actual production cost, in Canada there is a lot of political pressure building against the Tar Sands because of the environmental damage involved in production. This could lead to a freeze or decline in production, or increased costs from new environmental standards.


On Nov 14 11:12 AM jerrydd wrote:

>
> I've seen evidence NG is being sold under production costs in most
> of the NG shale plays which would make them not a good investment.
> They took the financial statements and compared them to output and
> production costs were $5-8/mmbtu and now selling for $4/mmbtu by
> overstating reserves vs actual historical output. Not good!
>
> Other details is the old rigs were dropped because the new ones produced
> far more NG than the old ones/$. Obviously production has increased.
>
>
> With the getting stronger El Nino the winter is likely to be warm.
> Lucky for us in Fla, Gulf it cuts hurricanes too.
>
> Oil sands production costs is close to $30/bbl according to the producers,
> not $80. But they are limited to what they can produce so not a market
> mover.

Nov 15 02:27 PM

[Piper:]

hey ferdinand - it means oil is fairly priced. did you take economics 101? at about 80/bbl, new supply is stimulated. forget 30/bbl existing producers, the guy is talking about new supply, ie new projects in the oil sands.


On Nov 14 09:17 AM Ferdinand E. Banks wrote:

> "Oil trading at the marginal cost of new supply". What is the point
> in making a nutty statement like that?

Nov 15 11:39 PM

[StockMaster...:]

$80 per barrel is close to the marginal cost of supply? Maybe bringing on new tar sands projects, but not traditional drilling rigs.

Nov 16 08:45 AM

[chris coonan:]

I am in China, and every taxi and bus runs on Natural Gas....why, because the cab drivers think they can drive twice as far (or pay half the cost of gas). I don't know what the real savings are, but Natural Gas is competing very well with Petro here in China, and is easy to get at filling stations on the roadside.

I can only imagine that diversity in fuel is good for America, and that gas stations should start to offer more choice to consumers. I think that it has been held back/manipulated in America, since the big oil companies control franchises.....

Oil has become sort of a narcotic in America, and the drug pushers are very big and powerful.

It is time for science and technology to start ruling the market.

Nov 17 07:04 AM

[mbkelly75:]

One other thing to keep in mind about returns from Natural Gas stocks is the monthly payout is based on prices from 2 months ago, so they are always off from the market price today. It took me awhile to find this out when I first invested in a Canadian NG producer stock.

Nov 17 04:46 PM