Can Natural Gas Companies Make a Comeback?

By Markets Fool.com

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The stars have not aligned for natural gas producers. The combination of a warmer-than-expected winter and resilient production has led to record inventories and sub-$2 per thousand feet gas prices. The unfavorable environment has depressed stock prices for sector leaders such as Range Resources(NYSE: RRC)andEQT Corporation(NYSE: EQT) and has hurt less-capitalized companies even more. Although the spot price for natural gas remains weak, there are nevertheless some reasons for investors in these beaten down gas producers to have some cautious optimism:

1. Consumption is slowly but surely rising
The lower natural gas prices are leading to increasing consumption. One example of increasing demand is in electricity generation. According to statistics from the Energy Information Administration, natural gas will account for 33% of U.S. electricity generation in 2016, surpassing coal's 32% share of electricity generation for the first time ever on an annual average basis. The trend of increasing natural gas usage will continue as more coal plants are phased out.

Demand is also rising for other uses such as for energy and feedstock for the fertilizer and chemical industries. Because more industrial companies are taking advantage of the low natural gas prices, the EIA expects total natural gas demand to rise to 76.6 billion cubic feet a day in 2016 and 77.2 billion cubic feet a day in 2017, up from the 75.5 billion cubic feet a day in 2015.

2. LNG exports are ramping up
In addition to increasing electricity generation and industrial demand, export demand is rising. In late February,Cheniere Energy made its first shipment of LNG from its Sabine Pass export terminal in Louisiana, marking the first time that a company has exported LNG in the lower 48.Analysts expect gross LNG exports to amount to 0.5 billion cubic feet a day in 2016 and 1.3 billion cubic feet per day in 2017. While the LNG exports aren't much compared with the the total expected U.S. natural gas production of 79.68 billion cubic feet per day for 2016, the exports will narrow the current natural gas oversupply in the marketplace, which is estimated to average around 3 billion cubic feet per day in 2016.

Rebounding crude prices will also improve the natural gas supply imbalance in the long run. Because crude prices are correlated with natural gas prices internationally, higher crude prices will translate to higher overseas natural gas prices and will widen the price gap between international natural gas and U.S. gas. The wider spread should spur more LNG exports and boost demand.

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3. The lower rig count will eventually translate to lower supply, and the moderate weather won't last
Although supply has been remarkably resilient, the natural rig count hasn't been. According to Baker Hughes,there were only 89 operating natural gas rigs for the week of March 18, down 5.32% from the previous week and off by 63.22% from a year ago.

Source: EIA.

The 89 operating rigs marks the lowest level of natural gas rig activity in the 29 years that Baker Hugheshas kept track of such data. Similarly, the adjusted natural gas rig count, which is comprised of the number of natural gas rigs plus 0.25 times the number of oil rigs, is also at an all-time low (the adjusted natural gas rig count includes oil directed rigs because many oil wells also produce natural gas).

The low rig count is bullish for future prices. As EQT CEO David Porges put it, "there is a longer lead time between spuds and marketable production than there used to be' because rigs have become more efficient." Porges nevertheless "consider[s] rig count to be a reasonable, if rough, leading indicator of natural gas production". Because rig counts are still a leading indicator of production, the current resilient supply isn't guaranteed to last and supply growth could be slower than expected as production from existing wells declines.

Mother Nature could also aid natural gas prices. Although no one can predict the weather, it is a safe assumption that the recent period of moderate temperatures isn't guaranteed to last. If the coming summer is warmer than expected, the record inventories will recede and sentiment will improve.

Better times ahead
Because of these conditions, the EIA estimates thatHenry Hub spot prices will improve to the $3 per Mcf range in 2017, up from its estimate of $2.25 per thousand cubic feet for 2016. Given the $3 range assumption, Range Resources and EQT are both attractive.Both Range Resources and EQT have substantial assets in theMarcellus and Utica, where production is expected to double from by the end of the decade from present levels, andwhich experts think might have enough recoverable natural gas to meet U.S. demand for multiple decades. Because the geography is favorable, the wells in the two plays also have average breakevens of below $3 per thousand cubic feet. The research firm Wood Mackenzie estimates that Range has the lowest breakeven in the South West Marcellus of around $2.60/Mcf while EQT states that 'given the industry-leading cost structure of our core Marcellus acreage and potentially the Utica, EQT can make excellent returns at mid-$3 gas [when factoring other costs]'.

Range Resources and EQT's low production costs and valuable acreage make them ideal natural gas plays in times of uncertainty. The companies' low production costs and financial flexibility allow them to survive until the market improves and their valuable acreage affords them substantial leverage once prices rise. Range Resources and EQT are two companies that will probably make a comeback when natural gas prices increase.

The article Can Natural Gas Companies Make a Comeback? originally appeared on Fool.com.

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