Is It Too Early to Start Building Positions in Natural Gas Stocks?

by: Alex B. Gray

While consumption increased during the 1950s and 1960s, natural gas prices traded for pennies per Mcf, but increased steadily from only $0.07/Mcf in 1950 to $0.22/Mcf by 1973. After 1973, natural gas prices began to move sharply higher, which saw the average annual price rise to $2.46/Mcf in 1982. The price stabilized and then fell back below $2/Mcf in 1986 where it remained in a tight range until the end of the century.

The year 1999 was the beginning of another explosion in natural gas prices, which saw the average annual price rise from under $2/Mcf to a peak of nearly $8/Mcf in 2008. That also was the same year natural gas prices began to collapse due to poor economic conditions exacerbated by new technologies that resulted in new supplies.

Over the last year, natural gas prices have hovered on one side or the other of $4/Mcf. Lower pricing and news of over supply have had a negative impact on many natural gas companies. While many believe we are entering the decade of natural gas, it may or may not result in higher prices at the wellhead. However, higher oil prices will certainly change the behavior of exploration companies as they try to shift from natural gas to the much more lucrative oil and natural gas liquids. This should result in declining supplies and at least a floor under current prices. However, the real catalyst for natural gas will be increased consumption through replacing other fuels such as coal and oil.

While some natural gas stocks have moved higher, below are a few stocks that have struggled to return to their prior glory and two of which are down substantially from their 2008 highs.

GMX Resources Inc. (GMXR) is one company working to increase its exposure to oil. The company is currently weighted heavily to natural gas production, but has relatively new acreage positions in the Bakken and Niobrara. The company has announced that it intends to aggressively pursue drilling in these new acquisitions but real production from these new plays will probably not start to pay off until 2012. Even if the company hits its projections with this new focus, its production will still be weighted 80% to natural gas in 2012. The core natural gas assets are located in the Haynesville, Bossier and Cotton Valley plays of east Texas. Nearly all of this acreage is held by production which will allow the company to maintain a more prudent drilling schedule while prices are low. An investment in GMXR would require one to be bullish on natural gas prices or so bullish on oil that 20% of total production will be enough to pull this company out of the mud. However, any major increase in natural gas prices should send this stock soaring which at its peak before natural gas prices collapsed was over $80 per share.

Penn Virginia Corp. (PVA), like many other natural gas weighted companies, is shifting its 2011 capital expenditures to explore for oil and natural gas liquids. In the case of PVA, management estimates that of its $345 million 2011 budget, 75% will go toward the exploration of oil and liquids. The largest percentage of this budget will go toward its newly acquired position in the Eagle Ford Shale. The company appears to be moving quickly to oil and natural gas liquids as it anticipates 25-30% of production will be from oil and liquids in 2011 which is up from only 18% in 2010. The company’s natural gas assets are primarily in east Texas, Mississippi, the mid-continent and the Marcellus Shale. The company announced that it has suspended drilling operations in east Texas and Mississippi as these plays are held by production. The stock of PVA collapsed in 2008 along with natural gas and has only recovered modestly from those lows.

There are a few other stocks that came on hard times that are still trying to get traction such as Comstock Resources, Inc. (NYSE:CRK) and Chesapeake Energy Corporation (NYSE:CHK) which I wrote about on Oct. 3, 2010. Due to some strategic shifts and some attention from shareholder activist Carl Icahn, the stock price of Chesapeake has had a nice run, but still trades well below the highs it enjoyed before the 2008 collapse. Comstock has continued to struggle and the stock price has remained in a tight range since my article. Both Comstock and Chesapeake have a very heavy weighting to natural gas, but like other natural gas companies, spent 2010 repositioning themselves to increase oil and natural gas liquids exploration in 2011.

So is it too early to start building positions in natural gas stocks? The answer is maybe, maybe not. It depends on your time horizon. I do believe natural gas will struggle for the next year or so, but consumption should continue to grow at an increasing rate. The push to get the U.S. off foreign oil and to start using cleaner fuels seems to continue gaining momentum only to take a breath when the price of oil drops. However, each time, the movement seems to lose less momentum. There are several technologies that can help us reach this goal and I believe to some extent all of them should be explored, but natural gas would seem to be the logical and most cost effective solution to begin this transition. Typically the best time to invest in an asset is before the transition to its heavier use begins and while prices are depressed. Think about it this way: Would you rather have made an investment in residential real estate stocks in 2005 or have bought them in 2000 and sold in 2005 and now have the opportunity to look at buying them again?

I plan to dig into both GMX and Penn Virginia a little deeper to see if there is any real value here before making any commitments as well as look at the rest of the natural gas stock universe, including another look at Comstock and Chesapeake.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.