Weekly Natural Gas Recap - When Do Natural Gas Producers Become A Buy?

Summary

• Natural gas prices finished the week up 1.26%.
• With production reaching new all-time highs, natural gas producer equities are still near multi-year lows.
• When do natural gas producers become a buy?
• The catalyst we are looking for to change the sentiment for the sector is the impending increase in LNG exports.
• Shell notes that the LNG market will be in short supply by 2021 due to increase in demand, and we think this could provide a big tailwind for producers.

Welcome to the Weekly Natural Gas Recap Edition of Natural Gas Daily!

Natural gas prices finished the week up 1.26%.

With Mother Nature continuing to provide the tailwind for natural gas despite bearish fundamentals powered by higher production, natural gas prices marched higher this week followed by a sudden move up on Friday.

In our Friday NGF, we covered a few topics ranging from a short squeeze to algo-driven trades that explained the move, but what's been clear since the middle of February is that natural gas prices will largely be rangebound for the rest of this injection season. The lack of volatility has frustrated many of the traders we speak to, and energy investors that are looking at natural gas producers have all seemingly vanished as well.

With oil now receiving most of the attention, investors have reasons to ignore this highly value destructive sector for shareholders. For one, even as Lower 48 production marches to new highs and the composite of natural gas producers we follow showing ever higher natural gas production, these producers' stock prices continue to remain at multi-year lows. Even the fabled Cabot Oil & Gas (COG) has not rallied and received the same love affair as it did last year.

Just take a look at the returns over the last three years for the big 6: Southwestern (SWN), Range Resources (RRC), Antero (AR), Cabot, Chesapeake (CHK), and EQT (EQT).

But as the legendary Howard Marks said, "there's no such thing as a bad investment, just a bad price." This too applies to a battered industry like US shale gas producers.

For us with a contrarian bent at heart, the "value" presented in natural gas producers today does not represent that much of a value. Following the debacle that has gripped the entire energy sector, the most obvious of value to us today is the oil producers that continue to trade at absurdly cheap cash flow multiples. Yet, their natural gas counterparts trade at similar multiples. Now, of course, one could argue that investors are not assuming higher natural gas prices in the future, and we have been victims of that in the past (assuming higher gas prices in our NG investments), but a close and careful review of oil and natural gas fundamentals will reveal that oil has the clearest and obvious tailwind at least over the next 2-3 years, while natural gas is not so obvious.

However, that shouldn't leave us complacent of the opportunities that could present itself.

One of the clearest catalysts we wait for is the incoming surge in LNG exports

In a weekly natural gas recap titled, "Sleepy Market Usually Leads To Big Set-Up," we said:

If indeed producers start to limit capex spending (e.g. production growth), then we could see the natural gas market set-up for an amazing 2019.

Why?

If this year's production growth overwhelms the market, it would depress natural gas prices, and push production growth potential lower in 2019. But in 2019, structural demand led by LNG exports will push demand materially higher.

Source: EIA

According to EIA, LNG exports will increase by ~5.5 Bcf/d by the end of 2019.

Historically, and as close natural gas followers will attest to, the natural gas market is massively influenced by Mother Nature (e.g. weather). The 2016-2017 natural gas market was characteristically a very tight fundamental market. By our account, the natural gas market was some ~3 Bcf/d undersupplied, but nonetheless, Mother Nature wreaked havoc and ruined the bullish natural gas investment thesis coming into 2017. Followed by one of the warmest winters on record (the 2015-2016 winter), 2017 saw back-to-back months of severely warmer than normal weather that put the 2016-2017 winter as the warmest winter since 1958 by some accounts. This left storage balances at a 200+ Bcf surplus by April 2017, and even though storage fell to the 5-year average by November 2017, natural gas production had already started surging thanks to an increase in takeaway capacity.

But as natural gas exports (Mexico and LNG, Canada is still a net exporter to the US) increase materially in the coming years, this will lessen the bearish impact weather has on the natural gas market, while magnifying the effects of bullish weather.

As you can see in the chart above, US natural gas exports as a percentage of total demand has risen 5-fold since the start of 2015, and will continue to going forward. By our estimate, US gas exports as a percent of demand could double to ~20% by the tail-end of 2019. This would materially change the landscape of not just the US natural gas market, but the global LNG market as well.

Prior to this year, the market was also in the belief that the global LNG market was to be oversupplied until 2020. The change in take-or-pay agreements would upend how countries viewed LNG exports, but with China's recent massive shift in energy resource from the use of coal to LNG, Shell (RDS.A) (RDS.B) predicts that the global markets will be short of LNG supplies.

This gap that Shell is forecasting due to lack of LNG supply under construction could see itself turn into a huge potential tailwind not just for US natural gas producers, but also Canadian gas producers. (We are writing a section about Canada in our weekly WCTW.)

While you can see in the chart below that LNG capacity increases drop significantly post 2019, Shell believes that new projects will be announced this year that could see new capacity increases in 2020.

For us, we think once the majors start announcing new LNG liquefaction capacity increases, we would start to look for natural gas producers to buy.

And for investors looking at opportunities in the market today, Cheniere Energy (LNG) could present an opportunity to capture this impending LNG shortage on the horizon without necessarily taking the implicit bet that US natural gas prices will be on the rise anytime soon.

Conclusion

When do natural gas producers become a buy then?

We think the rangebound natural gas price action over the ensuing months will allow investors to take the "watch and wait" approach. We are currently looking for additional LNG projects to get announced either in the US or Canada for the potential turning point signal.

For now, our preference is to allocate capital to oil producers over their natural gas counterparts due to the difference in fundamentals between the two commodities, but as the golden rule in commodity goes, "low prices cure low prices." We hope to take advantage of this battered sector down the road.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.