E&P Stocks Could Get Gassed Up
By DIMITRA DEFOTIS
WHEN FEDERAL RESERVE Chairman Alan Greenspan laments high natural gas prices, it's got to be good news for the stocks of companies that find and extract the airy
commodity.
Chairman Alan gave his backhanded imprimatur to the group recently, worrying that higher oil and gas prices could pinch near-term industrial output.
Indeed, the July contract for natural gas has shot up 74% to around $6.37 per million British thermal units, from
$3.65 per million BTUs a year ago. And futures contracts imply natural gas will average around $5.00 per million
BTUs through 2009. That's way above average prices of about $3.00 in recent years, says analyst Barry Saga at
Brean Murray & Co, an investment banking and research firm.
Meanwhile, Baseline's index of oil and gas exploration and production stocks has risen 36% from last July's low.
We suggested then that natural gas prices were likely to rise, potentially helping some E&P companies (see
Weekday Trader, "Gas Could Be A Natural1," August 28, 2002).
Because supply in Canada and the Gulf of Mexico cannot be replaced fast enough, prices have climbed, and
importing liquid natural gas from abroad so far hasn't been easy or economical. So, as demand rises in an improving
economy, supply only tightens. Throw in the weather, which can affect supply (such as through hurricane damage
to rigs) and demand (an extra-hot summer or extra-cold winter), and prices may go higher still.
As some of these factors play out over the next year -- and with valuations of some gas E&P stocks at historic
lows -- investors could get in on the ground floor of what may be a secular change in the industry.
"The market has not fully discounted a more normalized equilibrium price of $4.00 to $5.00 per million BTUs,"
says Shawn Reynolds, a natural gas analyst with Petrie Parkman, an energy investment and research firm. "Most
companies are setting budgets at $3.25 to $3.50 -- they are making an acceptable rate of return there."
Exploration companies don't like price volatility (gas prices zoomed above $10.00 per million BTUs earlier this
year), because swings cause industrial users to cut production or switch fuel sources. For E&Ps, modestly higher
prices mean bigger profits that can be reinvested in new projects.
One potential beneficiary: Spinnaker Exploration, a pure play on Gulf of Mexico natural gas exploration.
Spinnaker has one of the industry's most extensive three-dimensional seismic databases of Gulf properties, but fell
from grace last year when it did not grow production.
This year it has projected flat growth, but is hoping for good news soon on its Cool Papa well adjacent to a
successful field, says chief financial officer Robert Snell. Higher prices have kept the company debt free so far this
year; its shares have climbed 57% from their lows last March.
"Given today's commodity prices at historical highs, and the relatively low cost of drilling rigs, it is a great
environment for a company like us that is prospect-rich," Snell tells Barron's Online.
As the stock climbed in February, John LaForge, co-manager of Phoenix Hollister Small Cap Value fund, sold his
position. But he started buying shares back again at lower prices over the past three weeks.
The stock is still well off its 52-week high (see At A Glance). The company is expected to grow cash flow by 17%
in 2003 and is trading at only four times 2004 cash flow, according to Thomson/First Call. (First Call's cash flow
figures add back depreciation and amortization, deferred taxes, depletion and exploration costs to operating
earnings.)
Another E&P company that would benefit from higher average natural gas prices is Noble Energy, which is close
to its 52-week high but is 24% off its adjusted March 2001 all-time high of 49.84.
Natural gas accounted for roughly 57% of Noble's reserves at the end of 2002, says Greg Panagos, Noble's director
of investor relations. Noble has expanded its production globally beyond the Gulf in recent years, and also profits
from its gas marketing business and several "downstream" businesses.
Noble should grow cash flow by 35% this year according to First Call. Noble expects to grow discretionary cash
flow by 10% to 15% annually over the next five years, according to Panagos.
And it's pretty cheap, says Mark Baskir, manager of the Strong Energy Fund.
"The company has put together a nice combination of properties, and they are starting to benefit from Equatorial
Guinea and some of China," says Baskir. "They now have a good production profile and big free cash flow."
Of course, the chances of a normal to cool summer, a big natural gas discovery in the Gulf or Canada, and a slow to
moderate economic recovery all could cause prices to drop more than the experts anticipate.
But when Alan Greenspan tosses and turns about higher natural gas prices, it probably means investors in E&P
stocks can sleep easier.
Full Disclosure
• The Phoenix Hollister Small Cap Value Fund holds 212,000 shares of Spinnaker Exploration, according to one of
the fund's analysts.
• The Strong Energy Fund holds 13,000 shares of Noble Energy, according to fund manager Mark Baskir. |
