Cabot: 122 Miles Of Profit

Jul.11.14 | About: Cabot Oil (COG)

Summary

Cabot has great positions in the Eagle Ford and Marcellus Shale.

The Constitution pipeline represents huge potential for profits to increase at the firm.

The FERC and the NY DEC stand in the way of the pipeline being built.

The chart is bullish which adds to my conviction that this stock is a buy.

Cabot Oil & Gas (NYSE:COG) drills mainly for natural gas in the most prolific part of the Marcellus shale in Appalachia. It drills mainly for oil in the Eagle Ford shale in Texas. I will be providing some background on the company to show how well managed it is. Next I will be providing color as to why the opening of the Constitution pipeline in the 2nd half of next year provides the stock with a huge catalyst going forward. Finally I will quickly look at the chart as it has been range bound for the past 16 months. I believe that it will break out of this range, meaning now is a perfect time to buy the stock.

Cabot was one of the first companies to start drilling in the Marcellus shale back in 2004. This proved to be a spectacular decision as the Marcellus shale has been one of the most gas rich shales in the country. Cabot implemented horizontal drilling in 2008 and it has led to enormous amounts of profits for the company. A cursory glance at the 10 year stock price chart would show you this. It has had production growth of over 40% each year for 3 consecutive years. In 2015 the company is guiding for production growth of 20-30%. This is not including the increased production that will likely occur from the Constitution pipeline as this is expected to be completed in December of 2015. This will lead to an even better year in 2016. The company has a very clear picture of its future growth potential. This means it must be valued highly.

The company's Marcellus shale wells consist of 17 of the top 20 wells in the Marcellus shale. Cabot has recently started to implement improvements to its drilling practices by using a ten well pad in the Marcellus shale which has allowed for cost savings and an increased production rate of a 30 day average of 168 Mmcf per day. Another innovation the company is undergoing with its drilling practices is shrinking of the space between lateral wells to 500 feet down from the usual 1000 feet in the Lower Marcellus. This change will likely increase recoverable reserves for the company. The reason why I am highlighting these two innovations is to help you understand that the profit growth isn't simply limited because the 'pipes are full'. In fact small increases in production will be occurring before the new Constitution pipeline is opened. These innovations will further improve profits as they save costs. The company has decreased its finding and development costs from $.73 per Mcf in 2009 to $0.40 in 2013. It is important to categorize this company as an innovator because it isn't an accident that the company has the most gas rich land in the Marcellus shale. As you can see in the chart, the company has 17 of the top 20 wells in the Marcellus shale.

Click to enlarge

Clearly the company has industry leading technology and experience which has put it in the great position that it is currently in.

The company also has another shale position in the Eagle Ford shale. The numbers are similar for the Eagle Ford as they are for the Marcellus shale. Its three pads produce between 89% and 92% oil. The rig count will increase from 2 to 3 in the third quarter of this year which will allow the company to produce more oil. As is the case with the Marcellus shale, the drilling at the Eagle ford shale is increasing in productivity which increases the profitability of the company. It has increased the length of lateral wells by 54% from 2011. The company has also increased the proppant usage per stage by 50%. Before I started to research Cabot I had no idea what this meant, so I will explain what proppant is. The most common proppant is known as 'frac sand' in the drilling industry. It is uniformly round treated sand or ceramic man made material that is extremely pressure resistant. This material keeps the fractures in the oil and gas rich rock from closing up allowing for more oil and gas to fill into a drilling well. Clearly this is an important way Cabot to get the most oil and gas possible from its wells. You can look at the stock chart of one of the companies called U.S. Silica (NYSE:SLCA) to see how valuable this product is to shale drilling companies.

SLCA data by YCharts

I will likely be doing more research into the 'frac sand' industry in the near future. Therefore, like the Marcellus shale the Eagle Ford shale has room for increased innovation and productivity, which bodes well for the future of Cabot.

The Constitution pipeline will be responsible for a huge increase in gas production in the Marcellus shale as you can see from the chart.

It will help the company reach its 2 Bcf per day drilling rate. Cabot owns 25% of the pipeline, Williams Partners owns 41%, Piedmont Natural Gas owns 24% and WGL owns 10%. As you can see from the map, the pipeline will be going from Susquehanna county Pennsylvania to Schoharie county New York. The Constitution pipeline will be supplying gas to the Tennessee and Iroquois pipelines.

The Tennessee pipeline supplies gas to Boston and the Iroquois pipeline supplies gas to New York. This access to premium markets will likely allow Cabot to receive higher prices for its gas. The pipe is a 30 inch 122 mile long open access pipeline, meaning local areas can also access the gas.

The main issue with the pipeline is regulatory in nature. The national agency that regulates the building of pipelines is the Federal Energy Regulatory Commission. The NY Department of Conservation is also in charge of regulating the pipeline. Alan Armstrong, the CEO of Williams Partners, stated: "the only real issue we are facing now is a regulatory issue that relates to the NY DEC, not FERC." In February of this year the pipeline was delayed by the NY DEC due to environmental impacts that it felt could be mitigated. The pipeline has already been delayed a year by the NY DEC as it was originally supposed to go online in Q1 2015. FERC is expected to approve the pipeline sometime this fall, just as Armstrong alluded to. FERC has already made there be changes to 50% of the original pipeline's alignment, so this agency hasn't been that easy to comply with either. If you only listened to the conference calls that Cabot has recently done with investors, then you would conclude that the pipeline was virtually guaranteed to begin servicing natural gas in the end of 2015 as it shows in the previous graph.

This may not be the case as websites such as Stopthepipeline.org are trying to organize people to stop this pipeline from being built based on eminent domain claims. If you went to this website you may conclude that the Constitution pipeline may never be built. The truth is likely in between these opposing factions as the pipeline will likely be built, but may face more delays from regulatory agencies. FERC's final ruling in the fall will be important to having the pipeline come online in late 2015/early 2016.

I believe that the Constitution pipeline can help the company return more cash to shareholders in the form of a dividend and a share repurchase program, as was discussed on the Citi Global Energy and Utilities conference call. The CEO stated that for the first time the company took a bottoms up look at the distribution model so far into the future (2016-2018). The reason why the company would look this far into the future for the first time is likely due to the Constitution pipeline going online during this time period. He stated that because of the ability of the company to realize higher price points for natural gas it will throw off a "significant amount of free cash." The company will be gaining this ability because the Constitution pipeline will be giving the firm access to the premium gas market. He stated that the increased cash flow will be used for share repurchases, dividends, and an expanded capital program.

If you analyze the chart, it looks as though the stock has been in a sideways correction for the past 16 months. I looked at previous sideways corrections in the stock's history to determine what the length of this current sideways correction will be. From July of 2009 to October 2010 the stock had 0 returns as well. This was a period of 16 months.

COG data by YCharts

Following this period, the stock went up over 160% in the next 10 months.

COG data by YCharts

In the 11 month period from July 2011 to June 2012, the stock also had 0 returns.

COG data by YCharts

In the 13 months after this sideways correction, the stock went up over 150%.

COG data by YCharts

Now looking at today's market, the stock has had zero returns for the past 16 months.

COG data by YCharts

This leads me to believe that the stock can certainly have big increase if it breaks out of the recent range. It is difficult to predict that this will mimic the previous percentage gains that I mentioned, which is why I mainly base my opinions on the solid fundamentals of the company which I discussed above.

The investment decision based on this analysis is to buy COG and to further look into companies in the proppant industry such as SLCA. This stock will be returning money to shareholders once the Constitution pipeline is up and running.

The short-term risk to this investment would be that the FERC and the NY DEC delay the pipeline further. The other main risk would be that natural gas prices go down significantly which I believe is not likely. If you are purchasing this stock based off my recommendation, I would recommend that you do further research on the price of this commodity.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in COG over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.