thestreet.com
Part 2: Rising Energy, Slowing Economy
By Christopher Edmonds
Special to TheStreet.com
Originally posted at 4:44 PM ET 11/29/00 on RealMoney.com
Editor's note: This is the second half of an interview by Christopher Edmonds
with Marshall Adkins, the managing director of energy research at Raymond
James. Edmonds' questions are in bold.
When you say "run out," that sounds dire. What do you mean?
When I say run out, I mean we will have consumers this winter that will not be
able to get natural gas. The dire interpretation of that is you will have people
freezing in Chicago. That is not what I am saying.
What I am saying is there will be a reallocation of the gas we have to the people
that will pay the most, the residential and commercial consumers, at the
expense of the industrial consumers. When I say we will run out this winter, all
things being equal we are going to have to curtail numerous consumers of natural
gas.
As recently as the winter of 1995-96 we were closing down schools and other
interruptible natural gas consumers. There is a high probability that will happen
again this winter.
The lowest natural gas storage we have ever seen was in 1996, when we had just
over 600 billion cubic feet left at the end of March. We have never tested storage
levels below 500 billion cubic feet. In a normal winter, my supply numbers show
we would end at about negative 300 billion cubic feet.
Can that happen? Of course not. It's probably impossible to get below 500
without major problems in the economy. So, what has to happen, as we move
through the next three months, is prices have to move up so price-sensitive
consumers get squeezed out of the market. We will be shutting down chemical
plants, ammonia plants and aluminum plants and that type of industrial
consumer who is price sensitive. I think that is the only way you can come close
to balancing the supply-and-demand equation this winter.
That is pretty dire. And it obviously means that your price forecast is
pretty dire as well?
Our official price forecast, which has been well above consensus for some time,
of $4.50 for natural gas is going to prove to be way too low. I certainly expect you
will see double-digit gas numbers this winter. We've already seen double-digit
prices in California.
The fact that California is running out in November is unbelievably scary. It
doesn't get cold in November. You're not even into the cold of winter. If you get a
normal winter, you will begin to run out of gas and begin to see gas rationing this
winter.
This is a simple supply-and-demand issue that has really been working its way to
a head over the last five years. Given normal weather, which appears to be the
forecast for the winter, we are headed for trouble. If we get a warmer-than-normal
winter, we may be OK. But that isn't likely.
And, if you are right, the supply problem may just compound itself as the
storage cycle is shortened as summer gas demand -- for electricity --
continues to escalate.
I think that is where the market is completely missing the underlying dynamics.
Let's argue we end up with a warmer-than-normal winter and we end up with 500
billion cubic feet of gas in storage at the end of the winter.
Still, we won't be able to inject as much gas into storage as we did last summer.
There will be more gas-fired power on-line, and last summer was much milder
than normal.
Let's say, best case, we are able to store as much gas next summer as we did
last summer. Still, starting at 500 billion cubic feet and adding 1,700 billion cubic
feet to storage, you start the winter at only 2,200 billion cubic feet vs. nearly
3,000. That's a big problem.
The real question is -- and I don't know the exact answer -- what price are
consumers willing to pay if they are willing to pay $6 today? My answer is
somewhere north of $5 and somewhere south of $50. In any case, gas prices are
more likely to move higher than pull back.
If that's the case, why aren't the stocks reacting in step with the
underlying commodities?
Let's talk about stocks for a minute. Your column last week was right on point. I
spend my life talking to [money managers]. And, they all say the same thing.
They are scared to death to buy these stocks with oil and gas at current prices.
But look at the visibility you have on prices today vs. 1997, and the [current]
stock prices are 20% lower. It is absolutely amazing that there isn't more interest
in the sector today.
Let's take an example, say the land drillers, companies like Nabors Industries
(NBR:Amex - news), UTI Energy (UTI:Amex - news) or Patterson Energy
(PTEN:Nasdaq - news). Are people going to stop drilling if gas prices get cut in
half? You're still talking $3 gas. These guys are making a mint with $3 gas. They
aren't going to stop drilling if prices drop by 50%. That is an amazing buffer you
have in the system.
And I don't think anyone is drilling oil wells assuming oil will be above $25 forever.
So, if it came down $10, that's not a big deal. It isn't likely to change anyone's
drilling plans. So you have a pretty big buffer between where drilling will slow
down and where prices are today.
So even if you consider oil in the mid-$20s and gas around $3, many of the
exploration and production companies are trading at historically low multiples.
And, if you plug in $6 gas and $30 oil, many of these companies are trading at
only one or two times their cash flow.
Still, the stocks haven't perked up. After third-quarter earnings, the oil services
group saw momentum leave the group and the charts rolled over. A lot of
investors bailed out for technical reasons. It's going to take some time to
regenerate confidence.
In addition, investors are focused on the potential overhang of oil supply that
could materialize in late April or May. My point is you have to get to April and
May first, and I don't think there is enough oil to get us there without breaking the
$40 price barrier. So oil prices may come down in April and May, but they are
likely to be coming down from much higher prices. As investors begin to realize
the supply-and-demand dynamics, they will come back to the group. I think that
will happen in the next two or three months.
So, if I'm an investor what should I do now?
I focus on the service side, so let's start there. There are eight or nine subgroups
in oil services, and I'd focus on three or four: the land drillers, the companies that
supply parts to the drillers and then the tubular manufacturers [which make the
steel pieces for rigs] and the offshore drillers.
The reason? They are very gas leveraged and they are highly operationally
leveraged. So if we are right on the gas call and the rig count, these companies
will put up very big numbers.
For example, Nabors, the largest land driller out there. We estimate next year's
earnings at about $1.70 and that they reach replacement-cost pricing sometime
in 2003. With today's trends, however, you could see replacement-cost pricing by
the middle of 2001, which means instead of $1.70 for the whole year, Nabors
could be on a $1.70 run-rate in the fourth quarter of 2001. You could see the
same type of upside for Patterson and UTI if current price trends continue.
We also like National Oilwell (NOI:NYSE - news), a company that provides
parts and services for drillers. Just about every rig in operation uses some
National parts.
In the tubular companies, a company like Maverick (MVK:NYSE - news) is
interesting, although there is a little more risk.
In the offshore drillers, we'd focus on the jack-ups like Ensco (ESV:NYSE -
news) and Rowan (RDC:NYSE - news).
Anything to avoid?
With the caveat that most of these stocks should go up, there are some sectors
that are lagging in earnings performance. I wouldn't say stay away from them, but
be aware that they are going to be longer term or longer-developing stories.
Sectors like offshore construction, deep-water companies like Transocean
(RIG:NYSE - news) and seismic companies. These stories will just take longer to
develop and don't have as much visibility. |
