"A 60:40 allocation to passive long-only equities and bonds has been a great proposition for the last 35 years …We are profoundly worried that this could be a risky allocation over the next 10." - Sanford C. Bernstein & Company Analysts (January 2017)
"Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria" - Sir John Templeton
"Life and investing are long ballgames." - Julian Robertson
Energy equities are historically out of favor, and I have written about this sector extensively, both publicly and privately, with a snapshot of some of my recent public articles listed below.
For somebody just getting starting reading my research, I recommend reading the above articles for a background of my views in this sector, and for a primer of where the energy market stands right now, including a record-low index weight in the S&P 500 Index, as measured by the SPDR S&P 500 ETF (SPY), with energy comprising only 5% of the S&P 500 index at the end of the second quarter of 2019.
For this article, I want to look at natural gas production in the United States, as the composition of the top-ten natural gas producers has changed dramatically over the past decade, which tells us a lot about what basins are economic, which basins are uneconomic, and where future shareholder returns are likely to come from.
Top-Ten U.S. Natural Gas Producers Year-End 2010
For reference, at year-end 2010, here were the top U.S. natural gas producers:
1. Exxon Mobil (XOM) - 3.9 Bcf/day
2. Chesapeake (CHK) - 2.6 Bcf/day
3. Anadarko (APC) - 2.4 Bcf/day
4. Devon Energy (DVN) - 2 Bcf/day
5. BP (BP) - 1.9 Bcf/day
6. Encana (ECA) - 1.8 Bcf/day
7. ConocoPhillips (COP) - 1.6 Bcf/day
8. Southwestern Energy (SWN) - 1.3 Bcf/day
9. Chevron (CVX) - 1.3 Bcf/day
10. Williams Energy (WPX) - 1.2 Bcf/day
(Source: Author, 10-Ks)
Williams Energy was actually ticker symbol "WMB", which is the Williams Companies (WMB) ticker, before Williams separated their pipeline and E&P businesses, and Williams Energy transformed from primarily a dry natural gas producer to primarily a liquids producer through a series of acquisitions and divestitures.
An additional note here, specifically, Chesapeake Energy and Southwestern Energy, which were both top-ten natural gas producers at year-end 2010, and in the list below (first quarter 2019), and top-three natural gas producers over the past decade, substantially moved their source of natural gas production, migrating from higher cost basins to lower cost basins.
The top-ten U.S. natural gas producers circa 2010 were dominated by the larger energy companies, and collectively, they produced 20.1 Bcf/day.
Top-Ten Natural Gas Producers First Quarter 2019
Range Resources (RRC) was the modern pioneer of Appalachia, and that discovery in 2004 grew into a behemoth by the end of 2019, with Appalachia-focused producers occupying 8 of the 10 slots of the largest U.S. natural gas producers.
(Source: Natural Gas Supply Association)
Appalachia-focused natural gas producers are now 8 of the 10 largest U.S. producers, shown in the table above, with a couple of comments as follows:
1. EQT Corp. (EQT) - 4.0 Bcf/day - Appalachia-based producer, who produces roughly the same amount of gas as the leading producer in 2010, Exxon Mobil.
2. Exxon Mobil - 2.7 Bcf/day - Major integrated E&P sits in the number two spot, bolstered by its acquisition of XTO in 2009, though U.S. production is down since that time frame.
3. BP - 2.3 Bcf/day - In the number three spot after acquiring BHP Billiton's (BHP) onshore assets.
4. Cabot Oil & Gas (COG) - 2.3 Bcf/day - Appalachia-based Cabot is neck-and-neck with Antero and takes the number four spot in this ranking, as of the date of the list/data.
5. Antero Resources (AR) - 2.2 Bcf/day - Appalachia-based producer is poised to ascent to #2 spot in dry natural gas production, as they continue to execute on their growth plan and is the second-largest domestic producer of natural gas liquids, after the Occidental Petroleum (OXY) Anadarko merger, holding roughly 40% of Appalachia's liquids rich acreage.
6. Chesapeake Energy - 2.0 Bcf/day - Appalachia leading Northeast producer, whose Appalachia dry gas assets are comparable to COG's, in my opinion. Total natural gas production is down for CHK year over year after selling their Utica assets. Chesapeake also gets substantial natural gas production from their Haynesville acreage (in addition to associated gas production from their oil related plays) which Tellurian (TELL) has made overtures to buy, but this is higher cost production compared to their Appalachia acreage position.
7. Ascent Resources Utica Holdings (Private Company) - 1.6 Bcf/day - Appalachia-based producer who was founded by Aubrey McClendon, the late former founder of Chesapeake Energy, in his next act after leaving CHK.
8. Southwestern Energy - 1.6 Bcf/day - Appalachia-focused producer who left behind their legacy Fayetteville founding assets to focus on the better economics of Appalachia. Owns assets in Northeast Appalachia, near COG and CHK, and is developing Southwestern Appalachia liquid assets.
9. Range Resources - 1.6 Bcf/day - Appalachia-based producer who is the founding modern Appalachia producer, drilling the first well in 2004, and who continues to own some of the best acreage in Appalachia today, from my perspective. Additionally, they have reduced debt over the last year, with overriding royalty interest sales, the latest to a group that included Franco-Nevada (FNV), pioneering a way, albeit an expensive way, for E&Ps to reduce debt. The silver lining is that FNV's implied valuation of RRC is much higher than the current share price today.
10. CNX Resources (CNX) - 1.4 Bcf/day - Appalachia-based former coal-focused company, has pivoted to become a top-ten U.S. natural gas producer.
Interestingly, the total cumulative production of the top-ten producers in the first quarter of 2019 was 21.7 Bcf/day, and the total natural gas production of the top-ten U.S. producers at the end of 2010 was 20.1 Bcf/day, as referenced earlier, so the cumulative production increase of the top-ten producers from 2010 to the first quarter of 2019, was 1.6 Bcf/day, or a total increase of just 8% in natural gas production for the top-ten producers.
Thus, the production profile is relatively the same. There has just been a wholesale change in the companies occupying the top-ten slots, with almost all the larger-cap producers vacating their production profiles, moving to a focus on liquids production, and ceding ground to Appalachia production, with Appalachia producers now occupying 8 of the top 10 slots, because Appalachia natural gas is the low-cost dry gas producer, outside of associated gas production.
Closing Thoughts - Focus On Appalachia
In my recent public article on Antero Resources (linked above), where I advocated that Antero should get consideration for the number one position in an investor's equity portfolio, a commentator, in the comments section, asked if I had just compared the disruptive growth of Antero, which had grown revenues at a 23% CAGR from 2014 to 2018 amidst a collapse in energy prices, to the disruptive growth of leading technology companies, including Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), Amazon (AMZN), Facebook (FB), Netflix (NFLX), and Apple (AAPL).
2) Did you really compare an upstream E&P to market leading tech company?
(Source: Seeking Alpha member IACMW)
My answer reaffirmed this comparison.
2. I did do the comparison. Appalachia energy production (Permian too), and specifically Appalachia natural gas production, has been disruptive to the entire energy complex, changing cost curves, allowing whole industry transformation (look at electrical power generation, LNG exports, industrial usage), and causing companies to transform (think SWN) or go extinct.
Clearly, the data above shows that Appalachia energy producers have disrupted the top-ten natural gas producers, effectively claiming 8 of the top 10 spots, once you consider that Chesapeake Energy and Southwestern Energy changed the source of their respective natural gas production from higher cost basins, to focusing on production in Appalachia.
In summary, energy is undervalued today, and Antero Resources, Cabot Oil & Gas, EQT Corp., Range Resources, Southwestern Energy, Cenovus Energy (CVE), Encana (ECA), Schlumberger (SLB), Occidental Petroleum, even Chevron (CVX), they are all undervalued today, in my opinion, and members of my research services know which equities I think are the most undervalued, and what role these aforementioned equities should occupy in an investor's portfolio.
Bigger picture, commodities are historically undervalued compared to equities and bonds. Bonds are at a dangerous precipice even compared to the building mania for passive investments. Fundamentals still do matter, fundamentals were always the wrong scapegoat, and I still believe 2019 is going to be a banner year for value equities, similar to 2000, as price discovery, after more than a decade of growth outperforming value, is poised to return with a vengeance.
To close, even though it has been a very difficult, almost decade-long stretch for value-oriented investors, with pockets of significant outperformance, including 2016, I think we are about to enter a golden age for active value investors who do the fundamental work who can find the future free cash flow-leading companies in the most out-of-favor sectors, and the most out-of-favor equities, including this public write-up, will be at the forefront of this opportunity.
There is historic opportunity in the investment markets today. I have spent thousands of hours analyzing the markets, looking for the best opportunities, looking to replicate what I have been able to accomplish in the past. From my perspective, the opportunities in targeted out-of-favor equities today are every bit as big as the best opportunities in early 2016, and late 2008/early 2009. For further perspective on these opportunities, consider a membership to The Contrarian, sign up here to join.
Disclosure: I am/we are long AR, BHP, CHK, CNX, COG, CVE, ECA, EQT, FNV, RRC, SLB, AND SHORT SPY IN A LONG/SHORT PORTFOLIO. 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.
Additional disclosure: Every investor's situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.