In the last few weeks Range Resources (NYSE:RRC) has rallied as the US natural gas prices have climbed from their recent low of $1.90/MMbtu to their most recent high of $2.53/MMbtu. However, there is a huge amount of over head resistance from about $2.25 to about $2.66. It seems logical that the rally will stop here (or at least pause). Perhaps it already has.
This makes more sense with the recent fall in WTI oil from its near term high of $106.43/barrel to its current $92/barrel. Many other commodities have fallen too. Further, Chesapeake Energy (NYSE:CHK), the 2nd largest natural gas producer in the US, is currently planning on an average price of $2.50/MMbtu for all of 2012. This tends to support the rationale for a rally end here.
On top of the end of the rally, there are many other reasons for RRC to fall. RRC is primarily a natural gas company. Its production is approximately 78% natural gas, 16% natural gas liquids, and 6% oil. Its great natural gas resources are primarily in the Marcellus Shale. Much of these are in Pennsylvania. This comes under Pennsylvania law, and Pennsylvania has recently passed the Unconventional Gas Well Impact Fee Act (Feb. 2012). This law imposes a new fee on every unconventional natural gas well drilled in the state. This is a non-negligible fee. RRC reported a $24 million (or -$0.15 per share charge due to this fee in Q1 2012). The fee will continue to be a problem for all new wells drilled in the state. On top of this new fee, the US Congress has recently introduced a new "Anti-Fracking" bill in both the House and the Senate. This could cause problems and expenses for RRC too. It is an emotional negative if nothing else.
As if the above wasn't bad enough, RRC has been losing money recently. From its Income statement, the net income has decreased for each of the last four quarters.
- Q2 2011 net income was $51,293,000.
- Q3 2011 net income was $34,755,000.
- Q4 2011 net income was a loss of -$2,989,000.
- Q1 2012 net income was a bigger loss of -$41,800,000.
This is a dangerous trend, and it is unlikely to correct itself with the still very low natural gas prices. The recent fall in oil prices will not help. It is also important to remember that RRC lost -$239,256,000 in FY2010. A return to this kind of performance would unquestionably pull the stock price down.
If all of the negative oil and gas fundamentals above were not enough, the overall market is in the midst of a retracement. Recent US economic fundamentals have been weaker than most expected. The Q1 GDP came in at +2.2% growth versus an expected +2.5% (and Q4's +3.0%). The most recent Durable Goods Orders data was -4.2%. The April NonFarm Payroll data showed a creation of only 115,000 new jobs versus an expectation of 162,000. I could go on. I could also mention the weak Chinese Industrial Production number for April of only +9.3%. The March reading had been +11.9%, and the expectation for April had been +12.2%. Slowing in China means lower energy and basic materials prices as China is one of the biggest basic materials and energy consumers.
All of the above are nothing compared to recent events in the EU. Greece is back in focus. Many are now wondering whether Greece will be able to stay in the euro, especially after the anti-austerity events associated with the recent Greek elections. The worry is growing so severe, Greeks are starting to withdraw their money from Greek banks for deposit abroad. In a mini-run on banks Monday, they withdrew $898 million.
The Spanish banking system is under fire due to its huge real estate problems. Recently, Reuters reported that Spain's government will demand its banks raise a further 35B euros in capital for provisions against loans. This amount would be in addition to the extra 54B euros Spanish banks need to raise to cover souring property loans. This may be just the beginning. Spanish real estate problems are legend. With 24.44% unemployment and approximately 80% home ownership, who is going to buy the empty Spanish real estate?
The Spanish situation is leading to fears about the Italian banks. On Monday May 14, 2012, Moody's downgraded the long term debt and deposit ratings for 26 Italian banks by one notch to four notches. All of these banks received a negative outlook after the downgrades. This came after Italy's top five banks were asked to raise 15B euros more in capital by June in order to meet the tougher capital requirements set by the European Banking Authority. Apparently their solvency is more at risk due to the high amount of sovereign bonds they own.
This increased recently with the further purchase of such bonds using LTRO funds. With the recently rising yields in both Italian (5.911% today) and Spanish (6.383% today) 10 year bond yields, those purchases have devalued. These assets are putting Italian banks more at risk. Plus, those same bond yields are threatening again to take off as Greek, Portuguese, and Irish bond yields did last year. Such a scenario would present huge capital requirement problems for both Italian and Spanish banks.
This all means that the USD will rise as the US is viewed as more of a safe haven. When the USD rises both commodities and stocks tend to fall in price. I am not sure this applies directly to US natural gas prices, but it does apply to Range Resources' stock price. Plus, the slowdown will mean more skimping by US consumers, and that in turn will mean a bigger glut in US natural gas.
According to the EIA, US natural gas stocks were 803 Bcf above their 5 year average for this time of year at 2,606 Bcf. At the current rate, US natural gas storage may fill up by the end of the summer. At that point the extra natural gas will have no where to go except onto the market. Extra natural gas entering an already glutted market would likely push prices down further. The market may not wait for the "filled storage state" to occur, the prospect of this may be enough to push the price of US natural gas down before that state is reached.
In sum, the EU recession is unquestionably coming. It is likely to be deeper than many are currently thinking. The EU problems are likely to be much harder to solve than many are currently thinking. Commodities are likely to fall further than many are thinking. The world slow down will be worse. RRC, with 78% of its production in US natural gas, will be one of the businesses hurt badly by the slow down. RRC's average analysts' earnings estimates for the next two years show a consistent downward trend over the last three months. The above fundamental and negative global economic information makes one think these negative earnings revisions trends will continue.
Don't forget that Chesapeake Energy is using $2.50/MMbtu as its average price estimate for US natural gas for 2012. This is not a price at which RRC will be profitable. RRC is over priced at a Price/Book of 4.25, a P/E of 253.44, and an FPE of 39.83. Sell into this rally; or if you are aggressive, short RRC. I can't see a big upside, but I can see a big potential downside.
Other companies with a large amount of natural gas production will have similar problems. A few of these are Chesapeake Energy , QEP Resources (NYSE:QEP), Ultra Petroleum (NYSE:UPL), and Cabot Oil and Gas (NYSE:COG). When the Chief Forecaster for Goldman Sachs, David Kostin, has a target on the S&P500 of 1275 in the next couple of months, it is that much more likely that the overall market retracement will continue.
Good Luck Trading.
Additional disclosure: I have only a small short position.