Considering the multi-year plight of natural gas, with a chart that resembles the Nikkei and very limited near-term prospects for fundamental improvement, investment anywhere in the sector is tricky and must be thought through with a long-term view. Inventories remain persistently high on the back of simply too much production growth over the past decade (buoyed by improving technology around extraction and shale development in North America). The lack of available infrastructure to transport gas combined with missing economic incentive to the other end of a pipeline has led to producers flaring natural gas. (Yes, that means simply burning the gas as opposed to trying to store, save or sell it.) A play on building out that infrastructure due to there being no demand for the product at the natural gas is not for the short-term. Now is the time to invest for the very long-haul, as natural gas prices may not recover for quite a while.
One thing to be aware of is to avoid the value traps and seek out the lowest cost growth around reserves and production growth. While natural gas prices will likely remain low for a while, you are always better off owning shares of a company that grows. One idea that made little sense to me was a recommendation to buy and hold Devon Energy Corp. (DVN) as a play on the recovery of natural gas prices. DVN is somewhat of a value trap operationally, as a company with fabulous promise in the early part of this decade (by being first and early in the Barnett Shale) but has yet to follow-up with a second hit anywhere close to the same magnitude. The company has shown little growth around production and proved reserves of natural gas (for those who are curious, an E&P company is valued on a Net Asset Value basis, not earnings, and thus, no production growth highlights stunted potential), with 10,283 BCF of proved natural gas reserves at year-end 2010, versus 9,757 and 9,879 as of the year-end 2009 and 2008, respectively (liquids production has fared flat as well, over the past couple of years, which is sort of an ominous sign). And while I agree that the balance sheet is in a very strong position, with $5.6 billion of cash and equivalents, as well as $1.2 billion of short-term investments, against total debt of around $9.2 billion as of the third quarter, hoping that the company announces another share repurchase program (they are about to complete a $3.5 billion repurchase program announced in May) is about the best you can hope for. Considering the stock is down 31% since the beginning of May, I am not sure that does much for you. I don't want to be too negative on DVN as they aren't horrible and management is focused on trying to grow the company's liquids base of production with the flexibility to do so. But DVN is not the best or most interesting play on the long-term recovery of natural gas prices by a long shot, especially because their largest natural gas producing asset may have peaked (the Barnett), as highlighted by the reserve numbers.
If you are looking for growth in reserves, a strong balance sheet, an exceptional management team and a pure play that has been beaten up, to own for a long-term natural gas price recovery, look at Ultra Petroleum Corp. (UPL). The company's stock price has been cut in half since the end of 2007, despite consistent reserve growth (when you are producing gas, and gas prices continue to fall, the value of your reserves, even if growing, falls too, unfortunately for UPL). Considering the strong operational results, when natural gas does plateau, UPL will be a prime beneficiary and as natural gas prices languish this is a good entry point around the stock. There are other companies that are similar, such as Southwestern Energy Co. (SWN), Range Resources Corp. (RRC) and Cabot Oil & Gas Corp. (COG) that have all done a good job too. The reason I highlight UPL is because the stock has had the most trouble relative to peers and thus, taking on a long-term investment in UPL has greater recovery potential.
If you are looking for a natural gas option play, look at EOG Resources, Inc. (EOG). EOG has a large natural gas footprint, with enormous and consistent growth in liquids (something that DVN has failed to do). EOG also has a strong balance sheet and has done a great job of transitioning operational focus from natural gas to liquids, with great success. If you are looking for liquids, with a natural gas option, EOG should be the choice.
Disclosure: I am long UPL, EOG.
