NATURAL GAS: IS THIS ARMAGEDDON?
Summary:
Oil prices are testing $10/bbl and gas prices are under $2/mcf. Weather will likely remain warm into the middle of next week such that the first 24% of the heating season will run some 13% warmer than normal and 15% warmer than 1997. If the rest of the season runs normal, this winter would come in 5% warmer than normal but 5% colder than 1997. This could have negative implications for
storage withdrawals and, thus, storage levels at winter's end. At this point, we plan to lower our oil price forecast soon and, depending on near term storage withdrawals, could also lower our gas price forecast. The E&P stocks are down 24% in the last 4 weeks and are now selling at 6.0x 99E EV/EBITDA on our revised 1999 oil price. If we do lower our gas price outlook, the group
will be trading near its historic multiple (6.9), suggesting that the group will trade sideways over the near term.
Highlights:
* RECORD WARM WEATHER. An area of strong low pressure over Alaska is resulting in record warm weather east of the Rockies, which should last into the middle of next week. By that time we will be 24% of the way through the heating season and will have likely experienced weather that was some 13% warmer than normal and 15% warmer than the same period last year.
* WEATHER OUTLOOK. The current pattern should begin to break down in the middle of next week. Subsequently, the forecast is generally for normal weather but predictions are difficult with a La Nina pattern, as such a pattern tends to result in very changeable weather. At this point, the prospects for some much colder than normal weather are slim as the air up in northern Canada is not all that cold. Thus, even when the Jet Stream dips into the central and eastern U.S. and allows this northern air into the U.S., temperatures are unlikely to drop substantially below normal.
At this point, if weather runs normal for the rest of the winter, the entire heating season will run 5% warmer than normal but 5% colder than last year. If weather consistently runs 5% colder than normal for the rest of the season, this entire winter would average 1.6% warmer than normal but 9% colder than last year.
* STORAGE CONCERNS. We estimate that withdrawals totaled only 100 BCF during November versus normal November withdrawals of 200 BCF and November 1997 withdrawals of 188 BCF. We were estimating this November to run as high as 260 BCF. If December withdrawals run 20% below normal (355 BCF versus a normal 446 BCF and our forecast of 500 BCF), we estimate that December's storage levels
will be 455-460 BCF above year-ago levels.
Without a quick return to normal weather and normal withdrawals, we run the risk of ending the winter heating season on March 31, 1999 with storage levels materially above normal. This would put serious pressure on gas prices over the course of the rest of the winter and would obviously lessen demand for storage injections next summer-putting pressure on gas prices even further into
1999. The next 2 weeks of withdrawal data will be critical.
* GAS PRICE WEAKNESS. While gas prices rebounded a bit in the paper market yesterday (to $1.96/mcf), prices in the cash market are fast approaching $1.00/mcf (actually $1.14/mcf). This is because there are simply NO BUYERS for gas in the cash market and certain sellers must immediately get rid of physical gas supplies (primarily due to operational constraints on pipelines).
* E&P OUTLOOK. Since early November the price of oil is down 22% and the price of natural gas is down 23%. The E&P stocks have partaken in this correction as they are down 24% while the S&P 500 is up 2%.
We believe the E&P stocks are currently discounting 1999 NYMEX oil and gas prices of $13-$14/bbl and $1.85-$1.95/mcf, respectively. The NYMEX futures strip for 1999 is at $2.07/mcf. We will soon lower our 1999 oil price forecast to $14-15/bbl. While our 1999 U.S. natural gas price forecast remains
$2.20/mcf, we believe it could come in lower if we are confronted with a large storage overhang.
* ARMAGEDDON? We could easily be entering a new era for the E&P companies. Our valuation work is based on the trends of the last 5 years when oil prices traded in a range of $17-22/bbl and gas prices traded in a $1.50-2.50/mcf range. The U.S. gas market has not changed appreciably; we are only suffering from a period of extremely warm weather. The only change is that this brief period of warm weather could have pricing implications into next summer due to the role of storage. The world of oil is a different story as supply could exceed demand for an extended period of time.
* INVESTMENT RECOMMENDATION. With a $14/bbl and $2.20/mcf 1999 NYMEX price deck, the E&P stocks are currently trading at 6.0 times debt-adjusted cash flow compared to a historical average of 6.9 times. At this point, we would consider selling all oil-levered names, particularly those with high debt
levels e.g., Pioneer (PXD-Hold-$10.81), Oryx (ORX-Hold-$13.19). The consolidation currently taking place in this industry will probably not bail these players out. The gas-levered names will likely trade sideways until the weather and storage withdrawals improve.
Warburg Dillon Read LLC or predecessor firm has acted as Manager/co-manager of placement agent in underwriting securities of ORX or one of its subsidiaries in the past three years. |
