If there was one commodity I wish I had a crystal ball to forecast prices for it would be natural gas. In the United States there are quite a few companies with enormous leverage to natural gas prices. If natural gas prices go up they are homeruns. If natural gas prices stay around $4, they aren’t going to work out too well.
For those of you bullish on natural gas, one company that would surely be a fine investment in a world of $7 plus natural gas is Exco Resources (XCO).
Exco has strong positions in two major shale plays, the Haynesville (80,000 acres) and the Marcellus (110,000 acres). The company is targeting 30% production growth for the next 5 years. It also believes it can fund drilling from cash flow and achieve a 20% pre-tax IRR at today’s commodity prices. I like Exco because directors own over 32% of the shares outstanding. I don’t, however, invest in Exco because I have no clue where natural gas is going. And in my opinion these shale plays are pretty borderline at $4 natural gas.
One very well known investor has however taken a big position in Exco. Wilbur Ross owns 7.5% of the company. And he has done so because he has a bullish opinion on the future of natural gas prices in the United States. Ross told CNBC earlier this year that he thinks that natural gas is going to be a key component in the coming years in helping the United States becoming energy self-sufficient. Ross is not blind to the fact that there currently is a “glut” of natural gas in the United States, but he thinks it will be cured by increased domestic demand as well as exporting LNG outside of the States.
I think it is a bit of a risky bet by Ross. It is going to take a large change from the status quo to increase domestic demand to the amount needed to offset the supply available. Any rebound of natural gas prices is simply going to give all of these shale players more cash to ramp up the drilling and production to even higher levels.
And LNG exporting is going to take a lot of capital.
But this is the style that Ross has used to make his fortune. He digs around the ugliest areas looking to place an intelligent bet. This is somewhat similar to his 2008/2009 investments in the financial industry. He takes on more risk than many well known value investors, but his successful bets have more upside.
Warren Buffett was also recently asked about investing directly in natural gas on CNBC. Here is the text of his reply:
BUFFETT: And, you know, I know we'll be using more natural gas, I know it's got all kinds of advantages and it's cheap on a BTU equivalent to oil and it's cleaner and all kinds of things. But in the end the price depends on supply and demand. And even though demand will go up some, I don't know whether supply's going to go up even faster than that. And so far it's been--the last few years I should say that, you know, natural gas has been pretty disappointing. It hasn't been disappointing in terms of finding it, hasn't been disappointing in terms of its performance, it's just been--there's been too much of it around. And I don't know--I'm not good at figuring out, you know, whether that will change a year from now, or five years from now, and I'm not in that game.
And that is just classic Buffett. There are no called strikes in investing. Buffett isn’t 100% certain on future natural gas prices so he takes a pass. I’d guess Ross isn’t 100% certain on natural gas prices either, but he sees huge upside if prices do turn. He probably thinks higher natural gas prices are more likely than not, but he is willing to bet on something with less certainty because of the high potential reward.
Exco is one of the independent companies that led the charge into these unconventional shale plays. The major oil and gas companies missed the boat on this and have been left behind. If natural gas starts turning around the only way that the majors can get into the game is to acquire a company that has locked up a big acreage position. I think Exco would be on a pretty short list of the first companies to get acquired.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.