2 Winning Ways to Play a Rise in Natural Gas Prices

With several reasons emerging to believe that natural gas prices could be headed higher, relatively balanced producers Anadarko Petroleum and Devon Energy are becoming attractive.

May 17, 2014 at 11:00AM

It seems to me that, for several reasons, the future of natural gas appears brighter than it has for some time. On that basis, those companies with something of a balance between oil and gas production -- Anadarko Petroleum (NYSE:APC) and Devon Energy (NYSE:DVN) immediately come to mind -- are themselves in the process of becoming even more compelling.

I believe that gas prices will ascend slowly but steadily for the next several years. While the October 2005 price of about $13 per million Btu is unlikely to be duplicated, at least during this decade, I expect progressively higher annual averages to become the order of the day.

What'll push gas prices higher?
Among the factors likely to lead to a strengthening of natural gas prices, I'd note:

  • The steady rate of retirements of coal-fed power plants and their replacement by natural gas-fired units: According to the U.S. Energy Information Administration, another 16% of our current coal plants will be shuttered by 2020, with most being closed within the next two years.
  • The effects of the blasts of cold that most of the nation experienced between November and March: The most frigid winter in years, coupled with the potential for strong cooling demand during the summer months, could prove challenging as it relates to boosting gas storage levels. Having dropped to just 822 billion cubic feet -- the lowest level in 11 years -- they'll need to be returned to near the 3.85 trillion cubic feet that we've averaged in late October for the past five years.
  • The beginning of LNG processing in the U.S.: That factor could begin to be felt in domestic pricing as early as next year.
  • The role that our nation's LNG could ultimately play, once it reaches critical mass, in reducing Russia's hold over its currently captive customers, e.g., Ukraine and much of Europe.

Source: Wikipedia.

Reasons to love Anadarko
Given those and other factors, I'm watching balanced Anadarko closely. In addition to its involvement in a host of U.S. onshore plays, including the gas-prone Marcellus and Haynesville Shales, the company is at work in the oilier Niobrara, the Wattenberg, and the deepwater Gulf of Mexico.

Internationally, its areas of operation include Brazil as well as various locations in Africa. Its most intriguing activity likely involves its huge Mozambique LNG project. The four-year-old effort being conducted by Anadarko and its partners involves two parts. First is the drilling of deepwater wells -- more than 25 so far -- which are expected to yield up to 70 trillion cubic feet of recoverable natural gas.

Second is a commercial LNG development onshore in the country, which sits in southeast Africa on the eponymous Mozambique Channel. Management believes that Mozambique is now headed for status as the world's third-largest LNG exporter.

Devon delivers
Devon operates exclusively in North America, namely in such locations as the Eagle Ford, the Permian Basin, the Anadarko Basin, and the Barnett Shale. It originally gained entry into the last-named play in North Texas primarily through the acquisition more than a dozen years ago of Mitchell Energy. That company's founder and CEO, George Mitchell, contributed many years and millions of his own dollars in the Barnett to proving the viability of horizontal drilling and hydraulic fracturing in the freeing of hydrocarbons trapped in shale formations.

The Oklahoma City-based company is adept at translating operating successes into financial results. In describing Devon's solid quarterly results last week, my Foolish colleague Arjun Sreekumar noted that, beginning next year, its Eagle Ford operations alone are expected to generate in excess of $1 billion in annual free cash flow.

Clearly of importance, despite its movement toward oil-prone plays during the past few years, is the company's gas production, especially from the Barnett and Anadarko plays. That output remains strong enough to render Devon's shares attractive amid a return to popularity by the clean-burning fuel.

The Foolish bottom line
There you have it. While the importance of oil is hardly declining for producers, the days of natural gas being something of a stepchild may be numbered. That trends feeds right into Anadarko's and Devon's sweet spots.

Three stock picks to ride America's energy bonanza
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David Smith has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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