EXCO Resources Inc. (NYSE:XCO) is primarily a natural gas producer. As natural gas prices plunged, its stock price plunged. Investors were so sure it should go down, it has 27.70% short interest as a percentage of the float. In some ways this is encouraging if you are thinking about shorting it. In other ways it makes it more vulnerable to short squeezes, especially when HFT/momentum traders are involved. Those folks just love highly shorted stocks with high trading volumes. The three month average daily volume for XCO is 6,316,170 shares. This is ideal for the HFT/momentum traders.
When the U.S. natural gas futures reached a near term bottom of $1.90/MMbtu in late April 2012, the HFT/momentum traders decided to push XCO back up on the natural gas price rally. They did this relatively quickly from a low of $5.65 per share in April to a near term high of $8.25 in May. Then the U.S. natural gas prices started to fall again. From their near term high of $2.75/Mmbtu, they have fallen to approximately $2.50/MMbtu currently. With the world economic picture getting worse by the day, U.S. natural gas prices seem destined to fall still further this time. Of course, the natural gas glut will have a lot to do with that.
Is the U.S. natural gas glut really that bad? Yes, it is. The EIA Monthly Update came out May 29, 2012. It stated that natural gas use for electricity was up in March by 39.6% year over year. Many people harped on this as a signal that demand was catching up with supply. Not so. This increase amounted to +0.2Bcf greater use of natural gas year over year during the month of March 2012. Some might say this is a lot. However, the data for the first two months of total U.S. natural gas production in 2012 (the third month's data doesn't come out until Thursday May 31, 2012) show that U.S. natural gas production has increased 390 Bcf over the first two months of production in 2011. If every month increased electricity generation use by the +0.2Bcf in March 2012, that would only amount to +2.4Bcf for the entire year. The increase in total U.S. production from 2010 to 2011 was approximately 1.67Tcf. Extrapolating from the first two months' data, the increase for 2012 stands to be about 2.34Tcf. This supply increase is almost three orders of magnitude more than the increase in demand from electricity generation (extrapolated from March's 40% increase for all of 2012).
Southern Company (NYSE:SO) -- a utility -- says it generated 40% of its electricity from natural gas in 2011. It plans to generate 47% of its electricity from natural gas in 2012. However, its rosiest estimate for natural gas use for electricity in 2020 is about 58%. This leaves little room for huge growth. SO may be ahead of the curve. It is a leading utility. However, its plans show that there is no huge future natural gas demand coming from electricity generation in the U.S. It will have to come from elsewhere. The most obvious use is for transportation. However, without a Congressional Natural Gas For Transportation Act, the adoption of natural gas for transportation will be a very slow process. How many of your neighbors have a car or truck running on natural gas? Very few people can say they know of even one. Very few people can say their city bus system or a local trucking company uses natural gas powered vehicles.
In other words natural gas prices are mired in a slump that is only likely to get deeper as the U.S. natural gas storage fills up this summer. U.S. natural gas storage is already far above its historical norm after an exceptionally warm winter and an over supply of natural gas due to the huge amounts of new production from the unconventional shale fields. The EIA put the amount in U.S. storage as of Mar. 18, 2012 at 2,774 Bcf. The norm for this time of year is 1,991 Bcf. The rise this past week was far above the usual rise for this off season week. It was 77 Bcf versus the 5 year average of 37.8 Bcf for this week. The maximum volume of U.S. storage is approximately 4,000 Bcf. At the current rate this will fill up sometime this summer. At that point all production may go directly into the already glutted market (if they don't draft new storage). Many pundits think this will cause a further fall in prices. Some are projecting a price of $1.34/MMbtu or lower. The fall in U.S. natural gas prices may start at any time before U.S. storage is full.
Some producers have cut back on natural gas production. However, this week's storage gain makes it clear that this is not stopping the increases in supply. The BHI U.S. Gas rig count was 600 for the week ending May 18, 2012. This was up 2 from the previous week. The U.S. gas rig count will not decrease to nothing due to the oversupply situation as some seem to think. Some drilling has to occur because leases are HBP (held by production). Other drilling is directed at more lucrative WetGas (NGLs). However, WetGas wells produce natural gas as well. Even oil shale wells often produce natural gas. The U.S. Oil active drilling rig number has increased 45% year over year to 1382 rigs. The wells completed by these rigs produce a non-negligible amount of natural gas. Throwing it away is generally not cheaper. Hence it becomes additional production.
XCO is not a bad company. However, it has limited resources. The company itself has said it may have to sell some of its resources in order to make it through this troubling time. A few of its weaknesses are:
- It has no PE or FPE because it is losing money on a GAAP basis, and it estimates that it will lose money in FY2013.
- Its debt ($1.92B) is higher than its market cap of $1.70B.
- It has a Levered Free Cash Flow (TTM) of -841.87M.
- It has lost money in both of the last two quarters on a GAAP basis (-$281.6 49 million in Q1 2012 and -$166.652 million in Q4 2011). It seems likely to lose even more in Q2 2012. One of the big reasons for the loss in Q1 was a write down of oil and gas assets. This was primarily caused by the low natural gas prices. Since this is done on a rotating 12 month price basis, the average natural gas price is likely to be lower in each of the next two quarters. This means further write down losses.
- In Q1 2012 total oil production was 192,000 barrels. Total gas production was 47,381MMcf or 47.381 Bcf. Total oil and gas production was 48,533 MMcfe. In other words natural gas was almost 98% of production. This tells you how exposed XCO is to natural gas prices.
- In its Q1 conference call it mentioned it might try to sell its midstream assets and/or other assets. It also mentioned it might try to get into the NGLs and/or the oil development business in a much bigger way. It as much as said that its strategy at this time is highly flawed. It is cutting it natural gas drilling roughly in half for 2012. It is good that management is admitting there is a problem. However, it is bad that management has been so slow to follow the trend being set by many of the leading companies. Two such high profile companies are Chesapeake Energy (NYSE:CHK) and EOG Resources (NYSE:EOG). Both now produce significant amounts of oil. That XCO ignored the well publicized lead of these two doesn't speak highly of the XCO management team.
- Some of XCO's development lands are in the Pennsylvania Marcellus shale. Pennsylvania recently passed the Unconventional Gas Well Impact Fee Act (Feb. 2012). This will cost XCO significant extra development expenses for its Pennsylvania wells.
- The U.S. Congress is considering a new "Anti-Fracking Bill". If this passes, it is sure to cause extra expenses.
- The current EU and world economic environment has a negative trend to it. The EU crisis is threatening to become a very severe crisis at any time. Some are even saying that Spain may now be the first to leave the Euro. Spanish bond yields are streaking upward. The 10 year Spanish bond yield is currently 6.644% (up 3.07% today). This is more than 500bps above the comparable German bond, and it is generally considered an unsustainable rate. Italian 10 year bond yields are 5.94% (up 3.02% today). Stock markets do poorly in times of extreme economic uncertainty. Small cap energy stocks get beaten down especially badly. XCO falls firmly into this weak category with a market cap of $1.70B.
- XCO had only 37% of its production hedged for FY2012 and only 2% hedged for FY2013. This could end up costing XCO huge amounts of money.
In sum XCO is a very troubled company. It could even go under if the low natural gas prices persist for long enough. If you own XCO, you should sell it. The HFT/momentum traders, who love to short squeeze high volume, highly shorted stocks, cannot keep up their up push for ever. This is especially true against the tide of falling U.S. natural gas prices and huge economic uncertainty in Europe. If you are an aggressive trader, you want to short this stock.
The two year chart of XCO gives some technical direction to the trade.
There have been no highly positive fundamental events for XCO. It has merely been short squeezed up by momentum/HFT traders. You are lucky that you can catch it with the slow stochastic at over bought levels. This is a good point to enter a short position. The 50-day SMA is firmly under the 200-day SMA. The strong downtrend is still in place. Most signals are "GO" for entering a short position in XCO at this time. If you don't like the risk of a short position, you might want to try a put option spread on XCO. The spread tends to take some of the volatility and time premium out of the options purchase.
Note: Much of the above fundamental data came from Yahoo Finance.
Good Luck Trading.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in XCO over the next 72 hours.