This article is part of our "Best Stocks for 2011" series where our Foolish writers pick their top stocks ideas for the year ahead. Click here to see a review of last year's picks and our 12 recommendations for the year ahead.
This year has been kind to most commodities. Rare earth metals? Ridiculous. Silver? Stupendous. Orange juice? Outstanding. Corn? Cowabunga.
Natural gas? Not so much. Prices are down around 24% this year, as the market remains stubbornly oversupplied. Weak postrecession demand has met with an abundance of gas flowing from the nation's shale wells. Pontifications that declines from conventional gas wells would overwhelm these unconventional supply additions have not panned out. Daily gas production in Texas is higher than it was a year ago. National production is up a chunky 6% or so, according to the latest government data.
So will this market turn around in 2011? I don't really know. But as a value guy, I am drawn to the beaten-down, overlooked, and unloved. While it's hard to find a value-priced oil stock today, you can't walk down Wall Street without tripping over a cheap-looking gas stock. So this is where I'm focusing my search. Now, how to choose among the legions of gas-weighted producers?
Well, I could just pick a high-cost producer and pray for $6 gas prices, but that doesn't seem prudent. Neither does investing in a player with a ton of debt, which could spell lights out if a natural gas rebound doesn't materialize in time. These considerations would seem to rule out companies like Goodrich Petroleum (NYSE: GDP ) , with its high all-in cost structure, and Delta Petroleum (Nasdaq: DPTR ) , with its scary debt-to-EBITDA ratio of nearly 10 times.
The sorts of companies that do make my short list include Ultra Petroleum (NYSE: UPL ) , Southwestern Energy (NYSE: SWN ) , and Range Resources (NYSE: RRC ) . Each company has low-cost operations and a dominant niche in one of the major unconventional North American onshore gas plays. For Ultra, that's the Pinedale. Southwestern is king of the Fayetteville, while Range reigns in the Marcellus. The firms strike me as shareholder-friendly, and I think any would make a fine addition to a Foolish portfolio. I can only pick one, however, so I'm going to go with Range Resources.
Here are a few points in favor of the Marcellus maven:
Massive captive resource base
Range pegs its Marcellus resource potential at 20 trillion to 27 trillion cubic feet equivalent of gas. The company can (and does) go looking for plays in other basins, but it doesn't need to. We're talking about decades of high-growth development ahead.
Range has announced it is seeking a sale of its Barnett shale assets. In October, I estimated that this package could go for $1.5 billion. After taxes, that could just about cover this year's capital budget. Such a deal would also narrow management's focus, probably improve margins, and also show how undervalued the remaining business is.
Free Appalachian option
In August, I posited that investors are getting a free option on other productive horizons (i.e. those shallower or deeper than the Marcellus formation) across Range's Appalachian acreage. The company has kept pretty quiet about this "stacked pay" potential, but that may change in 2011 -- especially if the shares slump back under $40, as they did this past summer.
While smaller integrated players pump cash into oil plays like the Bakken, the majors continue to show an interest in Marcellus acquisitions. Chevron (NYSE: CVX ) recently struck while the iron was cold, picking up Atlas Energy (Nasdaq: ATLS ) for $4.3 billion. Royal Dutch Shell bought East Resources for $4.7 billion earlier this year. Range is a larger prize, but not beyond these supermajors' means by any means.
Of course, this stock's not a slam dunk. One ongoing risk is that of a major backlash against hydraulic fracturing. Range has been proactive on this front, choosing to voluntarily disclose the frac fluid additives used at each drilling site. A state or federal ban of hydrofracturing is still a possibility, if remote. This practice has enabled shale gas deposits to become economic. Without it, Range doesn't have much of a business (and neither do many of the company's competitors).
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