Natural gas prices might struggle this year, but demand is expected to climb significantly over the long term. The short term weakness might exacerbate the woes of natural gas producers, who are already coping with the ~40% lower benchmark price as compared to last year. But this could be an opportunity to load up on some high quality names, like Rice Energy(RICE).
Natural gas prices have been under pressure due to soaring production and concerns regarding growing stockpiles. Despite the significant decline in commodity prices which has led to a drop in production activity, producers from the contiguous United States are still pumped 4.7 billion cubic feet per day more natural gas as compared to last year. As per latest EIA estimates for the week ending May 29, total natural gas storage has clocked in at 2.233 trillion cubic feet -- that's nearly 51% higher as compared to the corresponding week last year. Analysts expect storage to continue to grow to 4.1 trillion cubic feet by early November. As a result, despite the recent improvements on the back of warm weather forecast, natural gas prices will remain under pressure.
The cheap prices, however, will lure power plant operators to switch from coal to natural gas as the latter becomes more economical. The U.S. government is also encouraging plant operators to switch to natural gas, which is a cleaner burning fuel. Due in large part to these two factors, last month, around 5 billion cubic feet per day of natural gas displaced coal. With decline in natural gas prices, the coal-to-gas switching activity might accelerate, which will lift natural gas demand. Besides, several LNG export terminals are lined up to begin operations in the coming years, starting from Cheniere Energy (LNG)'s Sabine Pass terminal in Louisiana which will be up and running within six months.
On the supply side, the 15% decline in the number of rigs at Marcellus and 38% drop at Utica, two of the leading natural gas producing regions of the U.S., will eventually hit production growth. Besides, the slowdown in oil production will also impact associated petroleum gas output, which alone accounts for a little less than a quarter of the total gas supply.
The weakness in natural gas prices, therefore, could be temporary. As prices rise, the Canonsburg, PA - based Rice Energy could witness a change in fortune. Rice Energy is a relatively new natural gas producer that debuted at the stock markets last year. The company has been growing its production at strong triple-digit rates, but has struggled with the decline in natural gas price (before hedging) from $5.42 per thousand cf in the first quarter last year to just $2.42 in the previous quarter. As a result, despite the strong production growth, the company has failed to post commensurate increases in revenue and earnings. Rather, Rice Energy posted another operating loss of $31 million in the previous quarter, following a loss of $33.8 million in the comparable quarter last year.
Rice Energy's biggest strength is its high-quality asset base at Marcellus and Utica Shales in Pennsylvania and Ohio respectively, two of the largest and most economical gas producing regions of the U.S. Rice Energy owns 89,000 net acres at Marcellus Shale where the company holds a deep inventory of low-cost wells that will be profitable even in the weak pricing environment. The company holds 356 net undeveloped locations at Marcellus that breakeven at $2.60 per million Btu.
At Utica Shale, Rice Energy owns 57,000 net acres and here too, breakeven costs at 302 net locations are at just $2.35 per million Btu. The latest report from Ohio Department of Natural Resources (ODNR) is also a testament to the company's high quality asset base. According to the agency, producers drilled 878 horizontal wells and pumped 210 billion cfe of gas from Utica/Point pleasant zone in the first quarter, up nearly 13% from the fourth quarter. During this period, the best shale wells were drilled by Rice Energy. In fact, three of the most prolific wells belonged to Rice Energy, with each producing more than 1.4 billion cf of wet gas. In these terms, Rice Energy was ahead of its Utica peers, which includes Antero Resources (AR), Gulfport Energy (GPOR), Magnum Hunter (MHR) and Eclipse Resources (ECR), who drilled the most prolific wells in the first quarter. Although Rice Energy is currently getting most (~80%) of its production from Marcellus, with results like these, Utica is positioned to make a bigger contribution to the company's output in the coming years.
On top of this, Rice Energy has the firepower to post strong production growth in the down market. The company has a healthy balance sheet, with a net-debt-to-cap ratio of 34.6%, which is lower than its mid-cap peer average of just over 40%, as per data from FactSet and Topeka Capital Markets. Besides, the company has ample liquidity of $1.2 billion to cover its 2015 capital budget of $890 million which underpins the company's 75% production growth target for this year. Besides, Rice Energy can further solidify its liquidity through asset dropdowns to its MLP, Rice Midstream Partners (RMP).
Conclusion
Natural gas prices will likely rise in the long term and Rice Energy, which has a top-tier asset base, strong balance sheet and ample liquidity to withstand the current down turn, is positioned to capitalize on the price recovery. The company's shares have climbed by nearly 8.5% this year, but are still looking attractive. In terms of 2016 EV/EBITDA multiple, Rice Energy is one of the cheapest of the top Marcellus/Utica producers, as per data compiled by Thomson Reuters.
2016 EV/EBITDA | |
GPOR | 9.1 |
RICE | 9.34 |
MHR | 10.37 |
AR | 10.92 |
AR | 11.05 |
ECR | 11.24 |
COG | 11.63 |
RRC | 11.98 |
