This Barron's article supports your ideas about industrial demand but doesn't see a demand turn until December. Question is whether the stocks will move in anticipation of that increased demand.
Comeback for Gas
What one analyst sees on the horizon
By Cheryl Strauss Einhorn
Natural-gas demand is bottoming and should pick up by the end of
the year. So says Bob Christensen, a gas analyst with
FAC/Equities, who suggests that last week's National Association
of Purchasing Managers Index for August produced a bullish signal.
How so? Well, the NAPM Index is a leading indicator of U.S.
manufacturing; a reading above 50 generally means that activity is
expanding, while one below 50 means it is contracting. August's
number was 47.9%. That is up 9.9% -- 430 basis points above
July's 43.6.
And while the number is still below 50, the positive rate of change
"is very, very encouraging," Christensen maintains.
He adds: "Our empirical work on this subject shows that a change in
U.S. industrial natural-gas demand generally lags that of NAPM, on
average, by four months. Based on the recent data, this would imply
that U.S. industrial natural- gas demand may begin to turn positive
by December 2001."
That would be welcome news to this downtrodden market, which at
the beginning of the year was perhaps the brightest light in the
commodity field.
Natural-gas commanded more than $10 per million British thermal
units during the first quarter, thanks to meager storage and hefty
demand. But this choked demand from industry, which accounts for
44% of natural-gas use in the U.S.
In addition, the high prices early in the year encouraged imports of
natural-gas substitutes, such as No. 6 residual fuel, which tripled to
700,000 barrels a day, trimming gas demand by about 3.3%.
Demand was also hurt by a cooler-than-normal summer in the three
regions most dependent on gas-fired electric generation -- the West
Coast and the West South Central and South Atlantic states.
This created a new problem for the gas market: the prospect of
inventories swelling to more than three trillion cubic feet by the
beginning of the winter heating season. That would be 402 billion
cubic feet over the level 12 months before.
Thus, late last week, natural gas was trading on the New York
Mercantile Exchange for just $2.35 per MMBtus, or 77% below the
winter high. Futures are likely to stay depressed. In fact, Christensen
sees the price in the second half of the year averaging $2.80 per
MMBtus.
Frank Bracken, an energy exploration and production analyst at
Jefferies, agrees. He is "inclined to believe that September and
October will be more difficult than August from a pricing perspective,
and that meaningful gas-price momentum is still a ways off." His
target for the next six months is $3 per MMBtus.
The stocks of natural-gas producers, for the most part, reflect the
weak demand picture. Shares of Apache, Anadarko and Devon
Energy have all slid by 25%-30% since the beginning of the year.
(Devon, which previously had agreed to buy Mitchell Energy &
Development in a $3.1 billion transaction, said last week that it is
acquiring Anderson Exploration for $3.4 billion. The deals will make
Devon the top independent U.S. natural-gas producer.)
But Christensen likes the prospects of oil-and-gas service
companies.
Although the exploration and production outfits have been
aggressively seeking new supplies, with over 1,050 rigs in the field
these days, production keeps dwindling; it sank 1% in the second
quarter. Furthermore, the number of rigs in use seems to be
peaking. "If we drop rigs now, heaven help us by 2002," says
Christensen. "Then we'll see supplies fall by perhaps 3%."
Christensen predicts that the exploration and production group will
become more aggressive in its drilling, using more sophisticated
equipment. And that should benefit the gas-service specialists.
Companies he particularly favors include Key Energy, the largest
servicer of rigs and wells, and Unit Corp., which does the deepest
on-shore drilling in the U.S. His target for both companies' shares:
$25. Each was trading below $10 recently.
As mentioned above, Devon Energy announced last week that it
would acquire Anderson Exploration in a deal that values the
company at a debt-adjusted multiple of eight times cash flow -- a
sharp premium to Devon's multiple of about five times.
As a result, some Wall Street analysts lowered their target price on
Devon's shares to reflect the premium paid for the acquisition. One
of those analysts was Lehman Brothers' Tom Driscoll, who now
sees the stock eventually hitting $53, down from his previous
estimate of $69. Still, he notes that the acquisition will expand
Devon's reserves by 35% and raise the firm's book value by 44%.
Late Friday, Devon's shares were at $43.15, down 6.5% on the
week. |
