Amid Oil's Slide, Shale Gas Shines

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Includes: OIL, USO
by: Motif Investing

Summary

The decline in oil prices has investors betting on a relatively safer haven in US shale gas stocks, a few of which sat atop the S&P 500 gainers last week.

Gas drillers are ahead of oil producers in slimming down after two years of price declines.

The price of oil posted a nice rebound last week, but it was barely a dent in what has been a seven-month selloff in crude. Light crude closed Friday back above $32 a barrel. Seven months ago, oil was trading at about $60 a barrel. In the interim, the S&P 500 has fallen 9.8%, with the stocks of domestic oil industry-related companies particularly falling on hard times. Yet some investors have recently been betting that a relatively safer haven exists with U.S. natural gas drillers, making that sector a lone bright spot amid much of the entire energy industry.

As Bloomberg reported, gas drillers, led by Southwestern Energy Company (NYSE:SWN), were the top three performers in the S&P 500 Index last Thursday. Southwestern, which topped the index a second day, was followed by Consol Energy (NYSE:CNX) and Range Resources (NYSE:RRC). Cabot Oil & Gas (NYSE:COG) shares also gained.

Other gas drilling investment alternatives also have outperformed recently. The Shale Gas motif has gained 0.6% in the past month. In that same time, the S&P 500 has lost 6.5%. The sector's move higher has offered a reprieve to a group of companies that has been hammered for some time by low natural gas prices. Southwestern said last week that it's slashing 45% of its workforce as new drilling slows. The Shale Gas motif has fallen 49.6% in the past 12 months. The S&P 500 is down 5.6% in that time frame.

However, as Subash Chandra, managing director of Guggenheim Securities, told Bloomberg, "Gas all of a sudden becomes a more intriguing trade." Natural gas-heavy drillers are already lean after two straight years of price declines, giving them a leg up on oil-focused producers that are only now taking measures to stem a supply glut, Chandra said. That may sow the seeds of a recovery to begin in the second half of the year as supply and demand start to balance, Barclays analyst Nicholas Potter wrote in a report cited by Bloomberg.

In the minds of some analysts, gas-heavy companies should be immune to falling oil prices. As Fadel Gheit, managing director at Oppenheimer & Co, bluntly told Bloomberg, "Gas has absolutely nothing to do with oil," he said. Meanwhile, future demand for shale gas looks to be on the rise. A recent report by Zion Research projected that global demand for shale gas will reach $105 billion in 2020, growing at a compound annual growth rate of around 9% between 2015 and 2020.

The major driving factor for shale gas market is rapidly increasing demand across the world, according to Zion. In an attempt to reduce its dependence on crude oil, the U.S. is highly focused on shale gas. Moreover, government funding coupled with large investment by many private players is expected to fuel the growth of this industry, according to the report.

The report pointed out that the high cost of production -- due to methods such as fracking -- compared to other conventional sources of energy is expected to limit the growth of this industry. But ongoing research and the introduction of new technologies are expected to eventually bring down cost of production.

A large number of proven reserves for shale gas in North America, Europe and Asia Pacific is expected to provide future growth opportunity to industry participants. Currently, North America dominates the market for production and consumption of shale gas -- in 2014, it accounted for more than a 75% share.

The combination of future demand with previous cost-cutting nimbleness could continue to foster the attraction of shale gas stocks, especially if oil prices remain subdued for the longer term.