I will admit that after years of work I seem to be able to slow down that itchy trigger finger of mine that is always too eager to buy a stock. I repeat over and over to myself that today won’t be the best price that Mr. Market will offer me for company XYZ, so save some cash to buy more tomorrow. But today I’m battling my mind as it seems to think that it knows that natural gas prices are going to start to improve fairly soon.
And this of course is very strange considering that all of 10 days ago I wrote about how predicting natural gas prices is far beyond my circle of competence:
Do you see what I mean ? 10 days is all it took for me to once again have to fight my mind over whether or not I have a clue as to predicting natural gas prices. A relentless enemy indeed my mind is.
Here is what my mind thinks it knows:
1) Natural gas companies are going into next year with only 30% of production hedged. And you can bet those hedge prices are on average less than they were in 2010 and 2009 when more production was hedged at higher prices. This lack of hedging is without question going to reduce cash flow for gas producers who are now selling gas at $4 spot prices rather than $6 to $8 hedged prices. That means a lot less capital available for capex and that means a lot less drilling in 2011. And of course less drilling means less production.
Here is a link to an article discussing the decrease in hedging:
2) Anyone who can shift capital spending towards oil and liquids and away from natural gas is doing so. So not only do companies have less cash flow to invest in drilling, they also are steering that cash flow to oil drilling instead of natural gas drilling.
There is no better example of this than Chesapeake Energy who is the most active natural gas driller in the United States. Consider these comments from their most recent conference call:
“If you're on our website or go to it at some point, note Slide 17, which is a projected CapEx budget over the next, well, I guess, three years going out to 2012. And in 2010, we'll spend 31% of our money on liquids CapEx, 2011 that should be 45%. And by 2012, we'll be spending almost 2/3 of our capital on liquids plays. So I suspect that people really don't appreciate that impact when we start replacing $3 and $4 Mcf with $13 and $14 Mcf. On a similar cost basis, you really see a huge move in per-unit value creation, and that will drive some numbers in 2012 and beyond and I think most people are not currently not modeling for. So that will remain a focus of the company. Of course, if gas prices, for some reason, were to come back at higher levels, we can always pick our gas drilling back up. But at this point, our goal is to go from 90% natural gas CapEx in 2009 to go to 35% gas CapEx in 2012.”
So that is the most active natural gas driller going from 90% of its spending on natural gas in 2009 to only 35% in 2012. That is going to make a difference. Especially when you consider that every other company is making the same move if they have oil to drill for.
3) Number 1 mentioned the fact that cash flows and thus capex will be reduced by the amount available. Number 2 mentioned that natural gas capex will be reduced by choice. And now number 3 is that much of the natural gas drilling that has been forced on companies as they have to HBP acreage is also going to be reduced. Much of the leasing of the big shale plays in the Haynesville and the Fayetteville was done in 2007 and 2008 with a three year window to HBP the acreage. In other words if you don’t drill it you lose it. That incentive for drilling is going to end in 2011 for many companies as they will have HBP’d what they needed to because the time window is ending.
I’m sure many people have had the same thoughts about a turn in natural gas for the same reasons. How can you not. Cash available to drill is going to go way down as the 2008 and prior hedges have run out. Nobody who can drill for oil would drill for natural gas if they have a choice. And those who were forced to drill for natural gas to HBP acreage will in 2011 be relieved of that burden.
The problem of course is being able to predict when the turn will come and I don’t think a person can do that very accurately. I’m inclined to think that the end of 2011 might be a good bet for some real tightening in the natural gas market but I am very aware that is not much better than a guess.
The move for a true value investor would be to buy equities who will benefit in a big way from a turn in natural gas, but will also do ok if that turn is further in the future than expected. My preferred vehicle is still Chesapeake as I really think their move to oil is not being appreciated enough by the market. But my mind and I are still fighting on that one. I’ll let you know if someone wins. A more prudent play would be something with a better balance sheet.
Oh, and if getting your head around natural gas isn’t hard enough, a person interested in many gas producers will also have to try and figure out how likely it is that there will be some kind of ban on fracking. You forgot about that one didn't you mind ?