Seeking Alpha

Oil and Gas Inv...'s  Instablog

Oil and Gas Investments Bulletin
Send Message
The Oil & Gas Investments Bulletin ( is an online subscription-based service that finds, researches, and profiles growing oil and gas companies that have high growth rates (or high growth potential.) Its team of writers work under Keith Schaefer,... More
My company:
Oil and Gas Investments Bulletin
My blog:
Oil and Gas Investments Bulletin
  • A Historic Date for Natural Gas Investors 1 comment
    Nov 22, 2011 3:26 PM

    This past Friday I had a chance to dialogue with Nathan Weiss of Unit Economics, an independent institutional research firm based in Boston. Nathan explains - below - why that day may turn out to have historic significance for natural gas investors.

    - Keith

    To natural gas investors, 11/11/11 will, in hindsight, be remembered as a historic date.  Friday marked the first time since November of 2002 that the 12 month forward US natural gas price moved to $4.00/Mmbtu (1 Mmbtu=1 mmcf).

    We think this spells the end of highly profitable hedging for a large majority of natural gas producers.  That should have a negative impact across the board for natural gas stocks in 2012. Twelve month forward natural gas prices can be seen on the following chart:

    U.S. natural gas producers typically hedge more than 50% of their coming year’s production in advance, often telling investors that they are “trying to be conservative” and reduce risk.  They use the forward curve to improve earnings and cash flows, and by hedging E&Ps have added as much as 50% of their operating cash flows over the past five years--making gas E&Ps equal parts hedge funds and natural gas producers.

    This means lower cash flows for natural gas producers from their hedge books.  It will make life very difficult for natural gas E&Ps as we move through 2012 and they work their way through the majority of their remaining hedge books put in place when 12 month forward gas prices were 20%+ above spot prices.  Now the forward curve is only 11% above spot prices—which are lower in themselves.  It’s like having one of your two legs get cut in half.

    Here are the numbers:

    Over the past five years, on average, the 12 month natural gas future contract has been priced 21.93% above the spot price.  Prior to 2005, the 12 month forward futures price was, on average, equal to the spot price, as the following chart, depicting the % contango between the 12 month natural gas futures price and the spot price going back to 1991, shows (the pink line is the five year average):

    As you can see on the above chart, the current contango between the 12 month natural gas forward price and the spot price is 11.73% and falling.  That means lower cash flows from new hedging.

    Investment Conclusions

    Many natural gas producers have successfully used their hedge books over the last 3 years to greatly increase cash flows and help share price—by as much as 50%, thanks to a 20% contango on the forward price curve.  Now, not only is spot gas lower – at $4/mmbtu for the first time in 9 years--but the contango is lower too.

    This should mean that 2012 will be the year when the cash flows of many natural gas producers take a big hit—and therefore their stock prices should too.

    While this data may tempt you to run out and short a basket of E&Ps, there are a few complications that must be addressed.

    The first is that with the current 27.2:1 ratio of spot oil to spot natural gas prices, even a relatively small amount of Natural Gas Liquids (“liquids” such as propane, butane or condensate/pentane) production can substantially change the economics of a “gas producer.”

    For example, Chesapeake Energy (NYSE:CHK) produces 83% of their BOEs from dry gas, yet generates only 52% of their revenue from dry gas at current spot prices—that’s a big liquids component.  Cabot Oil and Gas (NYSE:COG) generates 95% of their BOEs from dry gas, but only 81% of their revenues at current spot pricing.  This substantially narrows the number of “gas” E&Ps.

    In addition, some E&Ps (Sandridge in particular) have taken to creating Royalty Trust/MLP vehicles – carving out gassy assets and selling them to retail investors at absurd valuations, raising substantial amounts of cash.  This game will continue into 2012.

    Lastly, some E&Ps are rapidly switching their production from gas to oil.  Chesapeake, for example, has decreased the percentage of their production that comes from dry gas from 90% in Q3 2010 to 83% in the most recent quarter.

    The following table lists the major U.S. E&P’s, sorted by the percentage of their production (in BOEs) that currently comes from natural gas (from least to most).  The farther down companies are on this list, the more vulnerable their cash flow and stock prices are to lower gas prices.

    It also shows their production mix a year ago (Q3 2010) to allow for comparison, as well as the percentage of revenues based on current production that would come from natural gas using $3.50 natural gas price realizations and $94 WTI crude realizations.

    As always, feel free to call with any questions!

    - Nathan Weiss

    Unit Economics, founded in 2008, is a Boston-based independent research firm providing institutional investors with insightful research on small and mid-cap equity securities and market themes.  Senior Analyst and company founder, Nathan Weiss, was the author of The Weiss Report, a monthly newsletter focused on risk arbitrage and market neutral strategies from 1998 to 2000. From 2000 to 2006 Mr. Weiss was a generalist analyst and portfolio manager at Noble Partners, contributing significantly to their outstanding returns.  Mr. Weiss holds a Master of Science in Investment Management from Boston University and a BBA in Business Administration from the University of Iowa.

    Unit Economics
    A Division of Weiss, Harrington and Associates, LLC
    44 School St., Suite 805
    Boston, MA 02108
    office: (617) 227-5871
    mobile: (617) 763-4415

    Themes: oil gas
Back To Oil and Gas Investments Bulletin's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (1)
Track new comments
  • jsingular
    , contributor
    Comments (28) | Send Message
    Do you have a source for the charts? They didnt show up in the article. Thanks for the insight into the futures curve. I always read your articles on oil & gas with a keen interest.
    23 Nov 2011, 08:21 AM Reply Like
Full index of posts »
Latest Followers


More »

Latest Comments

Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.