What everybody knows isn’t worth knowing. And everybody knows that we are in a natural gas glut destined to last for years. To which I say…
Horsefeathers. The “perpetual glut” argument comes from touts and tipsters who don’t know the first thing about the oil and gas business. They read about the huge flow rates of shale gas that is hydraulically fractured under high pressure and extrapolate those flow rates far into the future. It doesn’t work that way. Those high flow rates are only sustainable in the first flush of fracturing; as the water dissipates throughout the pores of the rock, it loses pressure and the flow rate comes down. By way of analogy, think gushers and stripper wells.
Even if the USA can move toward greater independence from foreign oil by tapping previously-unexpected access to natural gas near population centers, many gas consumers worldwide cannot. We are a nation of entrepreneurs. If we have too much gas, we’ll turn those “inbound” LNG facilities into “outbound” facilities and sell what we don’t use.
There are some stellar companies in this business -- conservatively managed, well capitalized, and in nations that respect and reward solid businesses. The public may not be buying right now but I figure, with Exxon (XOM) and Chevron (CVX) buying on the cheap, it’s a pretty good bet that they know more about the future trends in their business than some Wall Street “analyst” fretting over whether BP (BP) will miss Wall Street’s estimates for this 12 weeks by a penny.
XOM bought XTO overpaid for it, if you ask the Monday morning quarterbacks on Wall Street. I’m not asking. I’ve been watching and owning Exxon for 40 years and I’ve yet to see them make a poorly-thought-out move. With this purchase, they just became the biggest producer of natural gas in America. The same applies to CVX, which just bought independent natural producer Atlas Energy (ATLS). Then there are the joint ventures, acquisitions, and acreage buys by the likes of portfolio holding Statoil (STO) and Shell (RDS.B) and by former holding and once-again recommendation Total (TOT), which has a monster joint venture with Chesapeake (CHK). Total is a favorite anywhere in the low 50s, with exploration and production worldwide selling for just 8 times earnings and yielding a solid 6%.
The prolific discoveries in geological structures that were inaccessible prior to the development of new technologies, like the Haynesville, Marcellus and Eagle Ford formations, means there is currently a gas surplus. The Marcellus Shale by itself is believed to hold more than 260 trillion cubic feet of natural gas and it overlaps 4 states with massive population centers a short pipeline away in Pennsylvania, West Virginia, New York, and Ohio.
The time to buy, as the majors have demonstrated, is when the price is depressed and rising operating costs make it a difficult time for many firms to make a profit. This has made a lot of companies desirable while at the same time their stock fails to reflect that. A lot of these firms control significant acreage, but simply don’t have the deep pockets to ride out the cycle. I’m not recommending any firm as a takeover, though I imagine that will be the inevitable result for some.
Let me also point out a couple other dynamics of this industry, not all of which are unabashedly positive. First, we need to remember that because spot gas sells at $4, that doesn’t mean all producers are selling for such a low price. Utilities need to know they will have fuel for the winter. That doesn’t mean they’re going to blow their inheritance, but it does mean they will pay up. As a result, the biggest, most dependable producers often hedge much of their expected protection at significantly higher prices than spot.
Also, the leaseholders and landowners who actually own or have middleman-leased the acreage don’t want to just sit on it -- they want to see those royalty checks coming in. Glut or no glut, most contracts are structured in such a way that drilling activity will commence by x date and will continue for only a fixed period -- so it behooves drillers to explore, define, and produce.
Finally, where there’s oil there’s often gas and where there’s gas there’s often oil. Even if that isn’t the case, natural gas liquids are a big business and getting bigger. These condensates are highly desirable in places like Alberta’s oil sands, where they are used on site to dilute the heavier substances so they can slurry right on through the pipelines to the refineries. There’s more to this than just “gas!”
Long-time readers will not be surprised by my top choices in this area. In addition to buying the Bigs whenever they decline in price, I like the crème de la crème of the next level of producers. At the top of my list, by a country mile, is our old favorite and current holding, EnCana (ECA). This is a successor company to the incredible windfall Canadian Pacific handed us years ago when we received shares of the railroad, Fairmont Hotels, Fording Coal, and EnCana -- which has, itself, now split into the EnCana natural gas play and Cenovus (CVE), to hold its estimable oil properties, primarily in the Alberta tar sands. (But remember what I said about there being oil where there’s gas and gas where there’s oil!)
For my money, if I can buy only one natural gas powerhouse, I’d buy EnCana. If I can buy 10, I’d still buy EnCana first. In Canada, unlike the conventions in the USA, leases from the government tend to be “perpetual” -- you can sit on it until the market comes to you. ECA has properties in both Canada and the US, enjoys a bulletproof balance sheet, and stellar cash flow. They don’t come any better.
I also recommend for your due diligence Cenovus (CVE), the spun off, “previous “other half” of ECA. CVE got the tar sands piece of the company, with something like 135 billion barrels of bitumen as proven reserves -- much of it sitting right on the surface just waiting to be processed and refined. There’s more than a century’s worth of oil reserves there at the company’s current profitable run rate, with no “dry holes” to worry about. They know exactly what they have and where it is. And, in addition, they have a number of “run-off” natural gas properties, as well!
An equally strong balance sheet and nonpareil cash flow make this my second choice in oil, closely behind Imperial Oil (IMO) which I recently discussed in depth here. IMO is my #1 Canadian oil pick. ECA is my # 1 Canadian natural gas pick. And CVE is #2 to both. Between the three, I believe they provide a solid foundation for any portfolio that recognizes the continued need for energy in this hemisphere.
I think these three should be in every portfolio that seeks great assets in the ground. 70% owned by Exxon, IMO has even more oil sands acreage than Cenovus. As the US, and the world, beat a path to oil in a nation that honors its contracts and delivers what it promises, I don’t think you can do better than these three. I’ve done my due diligence and own all three. I encourage you to do your own research on these firms and see if you don’t agree!
Disclosure: We, and/or those clients for whom it is appropriate, are long ECA, IMO and CVE.
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