Natural gas

[txlaw]

"Wow!

On his call just now, Jeff Gundlach just unveiled his favorite investment idea: Buying up natural gas assets."

 

 

Read more: http://www.businessinsider.com/jeff-gundlach-buying-natural-gas-2012-4#ixzz1sLHC5kzr

 

While I disagree with some of Gundlach's opinions on the US being a tragedy waiting to happen, I believe he has the correct view on nat gas. 

 

Who cares what nat gas prices go to at this point?  Nat gas is likely trading at well below the marginal cost of production.  You want to be in a position to snap up nat gas assets from distressed companies.  Partner with the best to do that, I say.

 

I think you have to differentiate between spot nat gas and longer dated nat gas, looking at the futures curve, you do see it upward sloping especially when you go longer out. At that point I don't see prices getting too below marginal cost

 

That is correct -- I am referring to spot prices. 

 

The key is that the price of nat gas company ownership stakes -- even for the low cost producers in NA -- seems to be tied purely with the spot price in the US, which makes no sense to me.

 

I think if you make a bet on US nat gas producers as a whole, you are making the bet that the US  maintains its lead as the lowest cost producer over the long run in a commodity market that increasingly becomes global rather than regional. 

 

You could simply buy a basket of US nat gas companies that have good balance sheets, and you will probably do well over the long run.

[ExpectedValue]

I don't know how accurate that is. If that were the case you'd have a ton of hedge funds flooding into the space to trade the 'arb'.

 

I've looked at a few gas E&Ps recently and you're seeing the futures curve + their hedges being used to come up with price assumptions that are used to model the cash flows.

[txlaw]

I don't know how accurate that is. If that were the case you'd have a ton of hedge funds flooding into the space to trade the 'arb'.

 

I've looked at a few gas E&Ps recently and you're seeing the futures curve + their hedges being used to come up with price assumptions that are used to model the cash flows.

 

Let me clarify. 

 

When I say that that the price of nat gas companies are trading based on the spot price, I do not mean that the market is not coming up with cash flow models and calculating NPV based on forward prices in NA and hedges.  Indeed, it's fairly clear that the market prices of these NA producers are based almost solely on discounted cash flow models generated using these NA futures inputs (plus hedge prices) and estimated production.

 

What I mean is that the market sentiment on nat gas companies is tied to the spot price of gas, resulting in the assignment of very little/no value to the creation of a global nat gas market over the long term or to the value of unproved/possible reserves.  (I may not be using these terms properly, as I'm not an energy sector expert.)  Therefore, value investors are given the opportunity to "arb" the difference between NAV based on US futures price inputs (which, I think probably represent marginal costs at best) and the NAV based on average global futures price inputs, and further get to "arb" the difference between proved future production and total future production (proved and unproved). 

 

Perhaps I'm wrong on the unproved future production part, but I think you're seeing this thinking with all of these JVs where large producers are buying up stakes in exploration projects.  In fact, I think we will see M&A going forward that is directly tied to this "arb" opportunity.

 

Would love to hear others weigh in who are more knowledgeable and more experienced in the energy sector, whether or not they agree with me.

[petec]

I would say that the market, by and large, looks at NAVs of proved resources plus risked unproved (i.e. maybe 50% of unproved).  The key determinant of the NAV is then the gas price assumed, and IMHO the gas stocks are only just starting to look cheap if you use a conservative estimate of the marginal cost as the long run gas price.

 

I'd be very wary of assuming that there is value in the creation of a global gas market for several reasons.  First, the liquefaction and gasification of LNG is very expensive and eats a lot of the delta between current US gas prices and 'global gas' (i.e. Asian LNG)  prices.  Second, shale gas reserves are being found all over the world so there's no reason to assume that global gas prices will be high in 10 years (i.e. when the infrastructure is starting to gain scale).  And third, the US is not a particularly low cost gas producer globally: many of the LNG liquefaction plants operating today have supply costs measured in tens of cents, I believe.

 

That's not to say that the startup of 1-2-3bcf/day of liquefaction in the US won't shift the supply/demand balance for a year or so occasionally, but supply will respond and ultimately the price will be set by the (currently falling) marginal cost of gas.  Rather, the opportunity in US stocks comes when they are pricing in a below-marginal-cost price of gas for eternity, which they might be beginning to do. 

 

(IMHO the real significance of a global gas market, and of demand shifting from oil to gas, and of shale oil and other new sources of oil, is that we might be entering a 20-30 year period of declining energy costs.  Hope so.)

 

 

[txlaw]

I would say that the market, by and large, looks at NAVs of proved resources plus risked unproved (i.e. maybe 50% of unproved).  The key determinant of the NAV is then the gas price assumed, and IMHO the gas stocks are only just starting to look cheap if you use a conservative estimate of the marginal cost as the long run gas price.

 

Interesting observation regarding unproved resources being baked into the market assessed NAVs.  I confess I haven't looked at the space as a whole but have focused on companies where the ratio of unproved to proved is quite large and where I do not believe the market is fairly valuing what appear to be "hidden assets."

 

I'd be very wary of assuming that there is value in the creation of a global gas market for several reasons.  First, the liquefaction and gasification of LNG is very expensive and eats a lot of the delta between current US gas prices and 'global gas' (i.e. Asian LNG)  prices.  Second, shale gas reserves are being found all over the world so there's no reason to assume that global gas prices will be high in 10 years (i.e. when the infrastructure is starting to gain scale).  And third, the US is not a particularly low cost gas producer globally: many of the LNG liquefaction plants operating today have supply costs measured in tens of cents, I believe.

 

I agree that you have to factor in liquefaction and gasification into the cost component.  In fact, I recall someone -- maybe Boone Pickens? -- recently talking about adding $4 to $5 for LNG transportation costs in the current environment.  I expect that transportation cost will go lower as we get more permits issued, achieve more scale in the midstream supply chain, and improve the technology. 

 

I'm not so sure that the shale formations all over the world will be as prolific as those in the US.  According to XOM, there are a number of touted foreign shale formations that haven't responded as well to the fracking techniques used in the US.  Also, by virtue of the scale of the industry in the US and the expertise developed here, I expect that the US will indeed be the low cost provider of shale gas, though any views and explanations to the contrary are welcome. 

 

This statement intrigues me: "[M]any of the LNG liquefaction plants operating today have supply costs measured in tens of cents, I believe."  Would love to see more info on this, as this is material information that could change the thesis.

 

(IMHO the real significance of a global gas market, and of demand shifting from oil to gas, and of shale oil and other new sources of oil, is that we might be entering a 20-30 year period of declining energy costs.  Hope so.)

 

Completely agree here.

[txlaw]

Speaking of XOM and nat gas:

http://tech.fortune.cnn.com/2012/04/16/exxon-shale-gas-fracking/

[biaggio]

http://www.theglobeandmail.com/globe-investor/investment-ideas/david-parkinson/meet-the-man-the-shale-gas-industry-hates/article2405737/

 

Meet the man the shale gas industry hates

 

"Mr. Berman’s analyses of drilling and financial data tell him there’s less economically recoverable gas in the shale deposits than others have been saying, that production rates decline more rapidly than anticipated, and that natural gas prices would need to more than triple to make most shale production profitable."

[petec]

TXLaw: I should clarify that by 'tens of cents' I mean 10-99c, not 'teens'!  The comment stems from a distant recollection that input costs for Qatar and Gorgon LNG projects are in the $0.40+ range but a quick websearch has failed to come up with evidence for this.  I will let you know if I find anything more.

[sdev]

"Wow!

On his call just now, Jeff Gundlach just unveiled his favorite investment idea: Buying up natural gas assets."

 

 

Read more: http://www.businessinsider.com/jeff-gundlach-buying-natural-gas-2012-4#ixzz1sLHC5kzr

 

This is nothing new, he has been talking about it as his "favorite idea" since gas was above $4.00. Interesting how he has gone from in the shadows to in the mainstream so fast. Gotta love hot managers.

[lessthaniv]

not sure if this has been shared yet but i found it interesting.

 

 

 

[racemize]

At the dinner, Sandridge CEO provided his outlook for Natural Gas:

 

1) current 2 dollar prices were due to outlier winter (he may have said it was a 4 sigma winter or even higher, can't remember) expected to get to 4ish dollars after that glut is off, e.g., in the fall

 

2) longer term (e.g., next several years), didn't think it would get above 6, I think due to the number of players/new entrants in the last few years

 

He qualified that this was just his opinion, and clearly he's bearish on nat gas given their switch from 95% gas -> 95% oil.

 

Norm will probably have much better notes, but thought I would get this part out.

[txlaw]

At the dinner, Sandridge CEO provided his outlook for Natural Gas:

 

1) current 2 dollar prices were due to outlier winter (he may have said it was a 4 sigma winter or even higher, can't remember) expected to get to 4ish dollars after that glut is off, e.g., in the fall

 

2) longer term (e.g., next several years), didn't think it would get above 6, I think due to the number of players/new entrants in the last few years

 

He qualified that this was just his opinion, and clearly he's bearish on nat gas given their switch from 95% gas -> 95% oil.

 

Norm will probably have much better notes, but thought I would get this part out.

 

Thanks for posting.  Didn't know Tom Ward would be at that dinner.  Pretty cool.

[txlaw]

Loews' CC worth reading for Tisch's view on nat gas:

http://seekingalpha.com/article/543061-loews-ceo-discusses-q1-2012-results-earnings-call-transcript

 

One of the more interesting observations:

 

We’re always looking, but the problem is that they are not stupid in the market. If you look at the forward price for natural gas in the futures market, that anticipates that -- it anticipates that the recovery is going to come back to natural gas prices over the next 2 or 3 years. So my prediction of $4.50 natural gas prices is not substantially different from the futures market. And the people that are actually selling properties today are able to sell on the basis of the forward price for natural gas, not the spot prices. So to date, we haven't found any veritable bargains.

 

[Liberty]

http://online.wsj.com/article/SB10001424052702303877604577380470571678552.html

[PlanMaestro]

I imagine many of you are thinking of ways to get some margin of safety. It seems that a healthy balance sheet, that may be worth nothing when forced to drill, or good hedges that will eventually run out is not going to be enough.  These are some of the picks that I have been reading here and there:

 

- Lowest Cost (MMR, UPL, MCF)

- Liquids or oil (CHK, SD, BBEP)

- Sugar daddy, most probably private equity (XCO maybe, PSTR maybe)

 

Others?

 

 

 

[txlaw]

I imagine many of you are thinking of ways to get some margin of safety. It seems that a healthy balance sheet, that may be worth nothing when forced to drill, or good hedges that will eventually run out is not going to be enough.  These are some of the picks that I have been reading here and there:

 

- Lowest Cost (MMR, UPL, MCF)

- Liquids or oil (CHK, SD, BBEP)

- Sugar daddy, most probably private equity (XCO maybe, PSTR maybe)

 

Others?

 

ECA has also been mentioned by some folks as a low cost NA nat gas producer.

[txlaw]

Brookfield on nat gas prices over the long term:

 

Power prices across North America remain under pressure due to under-utilization of industrial capacity and the current over-supply of natural gas from drilling shale gas deposits. While few  predicted a $2 price for natural gas, the technological breakthroughs that have made this possible are very meaningful for the long-term health of the United States as more energy is produced from natural gas and less foreign oil will have to be imported.

 

Longer term, we believe that natural gas will revert to higher pricing as rising consumption matches supply and exporting becomes a reality. This will come about from market dynamics as global natural gas prices are now five times greater than U.S. domestic prices, and the oil to natural gas conversion factor is currently at historic highs.

[txlaw]

I imagine many of you are thinking of ways to get some margin of safety. It seems that a healthy balance sheet, that may be worth nothing when forced to drill, or good hedges that will eventually run out is not going to be enough.  These are some of the picks that I have been reading here and there:

 

- Lowest Cost (MMR, UPL, MCF)

- Liquids or oil (CHK, SD, BBEP)

- Sugar daddy, most probably private equity (XCO maybe, PSTR maybe)

 

Others?

 

Also, merchant power generators have been killed because margins are tied to the price of nat gas. 

 

Might be able to find some value there that is not directly related to nat gas production and distribution.

[PlanMaestro]

Also, merchant power generators have been killed because margins are tied to the price of nat gas. 

 

Might be able to find some value there that is not directly related to nat gas production and distribution.

 

Interesting. I was also thinking CLD Cloud Peak Energy that is the lowest cost thermal coal miner. It is not like coal is going to disappear, there are huge legacy costs.

[kevin4u2]

Also, merchant power generators have been killed because margins are tied to the price of nat gas. 

 

Might be able to find some value there that is not directly related to nat gas production and distribution.

 

Interesting. I was also thinking CLD Cloud Peak Energy that is the lowest cost thermal coal miner. It is not like coal is going to disappear, there are huge legacy costs.

 

It's interesting that Jim chanos thinks you should short coal since the economics for coal will never be the same.  Isn't that more important than legacy cost?

 

[kevin4u2]

I imagine many of you are thinking of ways to get some margin of safety. It seems that a healthy balance sheet, that may be worth nothing when forced to drill, or good hedges that will eventually run out is not going to be enough.  These are some of the picks that I have been reading here and there:

 

- Lowest Cost (MMR, UPL, MCF)

- Liquids or oil (CHK, SD, BBEP)

- Sugar daddy, most probably private equity (XCO maybe, PSTR maybe)

 

Others?

 

ECA has also been mentioned by some folks as a low cost NA nat gas producer.

 

Peyto is the lowest cost operator in Canada, and is lower than many US companies listed above. They just announced earnings that were quite good given the low AECO gas prices. I didn't expect profits to be that strong.

 

Even at the lowpoint of the cycle they are selling for 22 times annualized Q1 earnings.  That's right, they were profitable in Q1. If you haven't ever taken a look, it's worth it. They have excellent management focused on maximizing ROI. One of the highest total returns on the TSX for the past decade.

[PlanMaestro]

It's interesting that Jim chanos thinks you should short coal since the economics for coal will never be the same.  Isn't that more important than legacy cost?

 

The thing is that the thesis for natgas is still that it will eventually recover to $4 and eventually to $6. At those prices coal is still cheaper. Therefore if you believe the natgas price recovery thesis, there will be substitution but

 

(1) the lowest cost coal producer should keep intact its production quota.

(2) margins and production will be be more protected than natgas companies, because the substitution will take time

(3) coal price should eventually recover to historical price/marginal cost alongside natgas.

 

So its a way to play the natgas price recovery with more downside protection.

[MahOyster]

A very interesting presentation by Arthur Berman: U.S. Shale Gas:  Magical Thinking & The Denial of Uncertainty (http://www.nicholas.duke.edu/hydrofrackingworkshop2012/presentations/Presentation-Berman.pptx).

 

The author, a widely respected professional in the field, states among otrhers:

 

"The true break-even cost of shale gas is $7/mcf.  The price must rise above this cost for companies to survive:

• Production is impressive but most wells are not profitable.
  
• All plays have contracted to core areas a fraction of the size of the play as originally advertised.
  
• The shift to liquid-rich shale plays will deflate the gas over-supply and cause prices to rise.
  
• Environmental problems will limit the contribution of the Marcellus Shale."
   
  

 

 

And some more trails of Cheesapeke...

 

http://www.rollingstone.com/politics/blogs/national-affairs/rolling-stone-responds-to-chesapeake-energy-on-the-fracking-bubble-20120306#ixzz1oMwnx4gd

[PlanMaestro]

Shale Gas Set to Reshape Trucking

http://online.wsj.com/article/SB10001424052702304707604577422192910235090.html

 

But today, truck manufacturers are embracing natural gas for everything from bi-fuel pickup trucks like the Chevy Silverado HD to 18-wheelers that can burn natural gas either compressed, called CNG, or super-chilled, called LNG. Navistar International Corp.,  Cummins Inc.  and General Motors Co.  all are courting the market with new natural-gas powered trucks or engines.

 

Navistar's goal is to "expand to a full range of products using natural gas in the next 18 months," says Eric Tech, president of Navistar's engine business. This year, the Illinois company is introducing delivery trucks burning natural gas. Next year, it is adding long-haul trucks with its biggest engines.

 

Mr. Tech thinks that in a couple of years, one in three Navistar trucks sold will burn natural gas. "This is not a subsidy-driven market," Mr. Tech says. "It's developing on its own because the economics are compelling."

 

Corporations like UPS and AT&T  are buying the vehicles. AT&T recently ordered 1,200 Chevrolet Express cargo vans equipped to run on compressed natural gas, which General Motors said was its largest CNG vehicle order ever.

Ryder Systems began renting out natural gas trucks in California last year, so customers could kick the tires. The response has been so strong Ryder is expanding the program to Michigan and Arizona. And it's introducing them in truck clusters it operates for big box retailers like Staples Inc. SPLS and manufacturers including carpet-maker Mohawk Industries Inc.

[bathtime]

A very interesting presentation by Arthur Berman: U.S. Shale Gas:  Magical Thinking & The Denial of Uncertainty...

 

CHK addresses Berman and the RS article here:

 

http://www.chk.com/news/articles/Pages/1699243.aspx

 

Count me as a skeptic of Berman's thesis.