Why Natural Gas Producers Have Nothing to Worry About

Major dry-gas producers like Chesapeake Energy (NYSE: CHK  )  took a beating in the late 2000's as North American natural gas prices plummeted. Since then, natural gas prices have rebounded off the $2 per mmBtu lows to around $4.50 per mmBtu.

Even though Chesapeake Energy hastily switched its focus toward liquids-rich shale plays, its production mix is still 70% weighted toward dry natural gas. If Chesapeake Energy and other natural gas producers can begin to fetch higher prices for their dry-gas output, then free cash flow will explode upward as gas assets once deemed unprofitable turn into money-making machines.

By attempting to diversify its hydrocarbon production base, Chesapeake Energy is now investing 80% of its capital expenditures this year toward liquids plays. Back in 2010, roughly 10% of Chesapeake Energy's output was liquids. But due to aggressive asset sales and a complete refocus on liquids-shale output, liquids grew to be 30% of Chesapeake's total production.

Now that Chesapeake Energy can lean on various hydrocarbons to shore up its balance sheet, what can shareholders expect?

American natural gas producers' favorite chart
Back in 2000, coal-powered plants generated 52% of America's electricity, while natural gas trailed far behind with just a 16% market share.

Source: Energy Information Administration

Over the next 12 years, a completely different story began unfolding. Due to a combination of cheap domestic dry-gas prices, environmental benefits, the "war on coal," and the inability to export natural gas, natural gas quickly began catching up to coal. In 2012, natural gas powered 30% of America's electricity generation, while coal fell to 37%. 

What makes Chesapeake Energy really grin is that by 2040, natural gas will overtake coal as America's primary source for electricity generation. Keep in mind that as natural gas gains a larger share of the electrical-generation market, that market is also steadily becoming bigger. In 2012, America consumed roughly 4 trillion kilowatt hours; by 2040, the EIA is forecasting that to grow to a bit more than 5 trillion kilowatt hours.

Gaining market share in a growing industry means there are plenty of profits to be had in this sector. Keep in mind that the beginning of liquefied natural gas exports or a major relaxation of coal industry regulations could change these forecasts. 

Beneficiaries
Chesapeake Energy would be a clear beneficiary of this trend because higher levels of demand and access to foreign markets (via LNG export terminals coming online) will push the average realized price for its natural gas upward. This could turn its natural gas-producing assets (which make up roughly 70% of its output) into cash cows.

Another natural gas producer, one that has stuck its livelihood almost entirely in the Marcellus shale, is also set to reap enormous gains over the long term. Cabot Oil & Gas (NYSE: COG  ) has operations in two different shale plays, the Marcellus and the Eagle Ford. 

In the Marcellus, Cabot Oil & Gas is running six rigs on its 200,000 net acre position to try to boost output by 25%-45% this year. From 2010 to 2013, Cabot Oil & Gas was able to grow production from 130.6 Bcfe to 413.6 Bcfe; so if the past is any indication, 2014 will be a good year for production growth.

Almost all of Cabot Oil & Gas' output is dry natural gas. But due to the development of its Eagle Ford acreage, things are beginning to change. In 2012 Cabot Oil & Gas operated only one rig on its 62,000 net acres in the Eagle Ford. But due to the massive decline in dry-gas prices, Cabot Oil & Gas decided to accelerate its Eagle Ford development. Now two rigs are operating in the Eagle Ford, with management commenting on potentially adding a third sometime soon.

Foolish conclusion
The natural gas revolution has arrived, and it looks like it's here to stay for a while. Dry-gas producers have gotten hammered over the past few years, but maybe it's time to take a closer look at these two players. Not only do Cabot Oil & Gas and Chesapeake Energy produce enormous amounts of dry natural gas, but they are also diversifying their hydrocarbon-production base by investing in liquids-rich shale plays.

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Read/Post Comments (4) | Recommend This Article (2)

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  • Report this Comment On April 22, 2014, at 12:14 PM, rkhaldar wrote:

    There cannot be a end to a comment on such a volatile topic---GAS . GAS from Shale is having a say in USA . But we are skeptic about its success in other areas. There is so much of complexity in the Shale Gas Exploration , that only the market with suitable inputs available can exploit it . In India we have a Shale Gas Policy in place , but we require the infrastructure , willingness, Consultants , suitable wells. We are still in the infant stage and hope to exploit it to make our Energy requirement a success.

    What is the outcome of the European sector geo politics , how the different areas of the world react , major players place them selves, its all a uncertain future . I hear USA planning to export Coal to Eastern Europe , to support their energy demand in case Russia reduces its Gas supply. We may have Liberal market , global approach , but at the end its nationalistic view which always dominates . Today you may send coal to Europe but till what date . Politics changes , human memory is short and once again we make the same reasoning – To Err is to Human .

    I analyze the chart of the different Energy forms extrapolated in the article . I am doubtful its trend shown . I remember , other energy forms , Tar sands , Gas Hydrates , CBM , Wind farms , Solar farms , PV Cells , gaining prominence . Shale Gas is a success in USA now , along with Wind , Solar and also Nuclear taking prominence . But Coal still is the major player. Low quality coal and Lignite finds application successfully in newer environmental laws. So thing are going to be complex and bigger countries , economies and private players , research houses have to play a more responsible role to be in the race . Isolation cannot be the 21st century approach. I wish we are all level headed to bring the cost of what ever energy – be it simple wood also down. I still see poor people in the Tea producing garden collecting dry wood from the forest , its good , cheap and also the earliest form of Energy.

    Your quote –“The 21st century industrial revolution”

    My QUOTE – “Solutions and Application Revolution “, expanding its meaning – Not one solution , not one application , but multiple technological application with the synergy of robotics , computer applications , smart processing/modeling is all spearheading the success mantra . Countries , International conglomerates, KM players and AHEAD Thinking communities are the benefiters.

  • Report this Comment On April 23, 2014, at 2:45 AM, amvet wrote:

    I agree with your ideas that NG producers in the US will enjoy higher prices, but a NG revolution, no. A short lived NG uprising, maybe. http://ir.eia.gov/ngs/ngs.html

    US NG production plus imports could not keep up with demand this past winter and storage was pulled down 870 Bcf. There is doubt that the storage can be replenished by the end of October. Another cold winter and we will have a shortage.

  • Report this Comment On April 24, 2014, at 4:05 AM, callumturcan wrote:

    @amvet By natural gas revolution I meant over the course over 5-10 years as LNG exports pick up and the continuation of the rising trend of more natural gas powered electricity plants, which will increase natural gas prices. Natural gas production will rise substantially, especially if prices stay continuously above $5-6 mmBtu. ConocoPhillips commented on how they might consider focusing on natural gas plays more so if prices can remains in the $5-6 mmBtu range, and for 2014, 5% of Conoco's capex is being devoted to natural gas plays. Keep in mind LNG imports are virtually nonexistent at this point, so the drop in storage was due to natural gas production being curtailed, as seen by the number of natural gas rigs dropping from ~800 to ~340 within just a few years, and the abnormally cold winter we just had definetely sent natural gas prices upwards and depleted a significant amount of our natural gas reserves. As natural gas prices begin to rise, expect the natural gas rise count to rise as well by a substantial amount, thus why I suspect a natural gas revolution is on the horizon. It all comes down to how fast LNG export plants come online, and if that pushes prices up enough to justify further natural gas production investment. Also keep in mind that in the Bakken, roughly 1/3 of natural gas output is flared because of the lack of gas gathering systems, processing plants, and pipelines in the area. As more infrastructure is built out, this could substantially change. Plus in most shale plays, even if output is heavily weighted towards liquids output, natural gas is still being produced, which will further increase output. The biggest hope comes from the Marcellus shale, which has seen reserve estimates fall downwards but on average analysts still see roughly 100 trillion feet of technically recoverable natural gas in the Marcellus, and this doesn't even count in the potential of the Utica play. If we have another cold winter we could have a reduction in our natural gas storage, but that would increase prices upwards to $5-6 mmBtu like the last harsh winter we had, which could spur more investment in natural gas output. We can agree to disagree, but at least we both agree on the fact that natural gas prices are on the rise.

  • Report this Comment On April 24, 2014, at 4:24 AM, callumturcan wrote:

    @rkhaldar many other nations have the potential to utilize horizontal drilling and hydraulic fracking, just look at China and the potential energy evolution involving there. In my opinion, if India was more excepting of foreign investment, which could happen after the election results are finalized, then they to could try and tap into shale plays as oil majors will be able to have more freedom in their operations and won't be hindered by waves of regulations. Similar in Europe, England is going to try and create a better legal framework for its energy industry which could spur further investment in the energy sector, which is badly needed as EU production has fallen over the past 10 years and Norway's production turnaround hinges on major offshore projects coming online soon. I agree with you that everyone should work together to bring down the cost of energy across the board, but some countries have too much red tape regarding foreign private investment that they may be late to the race and will effectively raise the price of energy through project delays and shut-ins. We will have to see what happens, but regardless, US natural gas prices will most likely rise due to LNG exports and a rise in natural gas usage in electricity generation in America. But because prices are so low $4.50 mmBtu, American LNG exports will still be substantially cheaper than what Asian markets are paying ($16 to $20 per mmBtu) and European markets ($10 to $13 per mmBtu, even before factoring in potentially higher prices from Russia due to the Ukraine situation), which will help reduce energy costs across the board in numerous countries and if natural gas replaces coal, C02 emissions will also go down, further reducing the world's pollution problem. That's my take, and everyone is entitled to their own opinion.

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