One of the few natural gas stocks I follow is Peyto Exploration (PEY.UN-TSX) (PEYUF.PK), because it’s one of the best, lowest-cost natural gas producers, and I consider it a bellwether stock in the junior/intermediate natural gas space.
All the gas stocks languished through the spring and summer of last year, and then bolted upwards from September to December as gas prices jumped from $2.50 – $5/mcf (million cubic feet of gas) and most of the natural gas stocks have remained remarkably resilient in 2010 as gas prices have slid down from the $5.50 range to $4 (or lower in some cases).
Peyto’s most recent financials show they received an average price of $6.17 for their gas in Q4 2009 – well above spot prices, thanks to an effective hedging program. Yet they still had to announce a $65 million equity raise last week, to pay ongoing capex and reduce debt.
For me, that speaks volumes about the state of cash flow for the natural gas producers. When one of the lowest cost, most efficient and respected companies in the business have to dilute just for financial maintenance, it’s hard to see how the rest of the industry –particularly the intermediates and juniors – are creating any wealth for shareholders.
The flip side is that Peyto could reduce its monthly distribution payouts to shareholders (over $100 million), but that would cause the stock to drop. Raising equity keeps the payouts up, shareholders happy and the investment bankers happy. But the point is that to continue doing business the way it was before, Peyto has to raise equity and wait – like everybody else – for natural gas prices to turn up enough that it will give them their desired rate of cash flow. For now, equity (shareholder dilution) fills the gap.
That made me realize there are actually three break-even prices for natural gas producers in North America:
1) There is the full cycle cost of gas, where you amortize in all your costs; everything including the kitchen sink. Most analysts peg this number in the $6-$8/mcf range, though with lower royalties and bigger wells from horizontal drilling that number is going lower on high quality (read: liquid rich, i.e. butane, pentane) plays.
2) There is the half cycle cost of gas - strictly operational costs, not amortizing in land costs. These numbers vary widely across the industry, but generally fall between $3-$4/mcf. Again, analysts give higher numbers and producers (of course) give lower ones.
3) The last break-even price is the price at which investment bankers can no longer raise money for natural gas producers. For now, equity is filling the gap – The Filler Financings – for these companies which mostly have high debt and are now stuck in the same position as they were at this time one year ago – hoping natural gas prices recover. What is that price? No one knows, but we’re not there yet.
I see the US natural gas market is actually in better shape than Canada's right now – their storage inventory levels are now just within their five year ranges, while Canada is well into record territory.
For now, there is enough hope in the natural gas market that Filler Financings will continue. When the market falls below even Break-Even Price #3, then it’s time to buy.
Disclosure: Zero stock; I own none