3 Stocks That Could Gain From a Natural Gas Drilling Revival

An increase in natural gas drilling may be coming. But who will gain the most from such a resurgence? While producers would likely get a boost, service providers such as Baker Hughes, National Oilwell Varco, or Superior Energy Services could prosper the most.

Jun 17, 2014 at 9:43AM

A resurgence in natural gas drilling could be coming. Low inventory levels and growing demand may finally boost natural gas exploration plans. Who might benefit the most from this new drilling push? While producers would likely see some gains, it is oil and gas equipment and service providers such as Baker Hughes (NYSE:BHI), National Oilwell Varco (NYSE:NOV), or Superior Energy Services (NYSE:SPN) that could book the biggest advances.

Low natural gas inventories and growing demand 
Sustainable higher natural gas pricing is the one thing energy explorers need before expanding drilling plans, and that kind of price support might be building. Notably low inventory levels should keep prices relatively high in the near term. According to the U.S. Energy Information Administration (EIA), natural gas stockpiles were about 38% below 2013 levels and nearly 43% below the five-year average at the end of May.

Increasing natural gas demand should also support pricing. In the utilities space, use of the the clean burning fuel continues to grow. The EIA reported that natural gas-fired power plants accounted for over 50% of new electricity capacity added in 2013, and new U.S. Environmental Protection Agency rules, aimed at reducing utility carbon emissions, suggest that natural gas will only continue its market share gains in meeting the nation's power needs.

Natural gas exports are coming
While low natural gas inventories and steadily increasing demand by utilities should provide near-term price support, liquefied natural gas (LNG) exports could provide for noticeably higher pricing in the longer-term. North America's prolific shale gas reserves combined with a growing worldwide LNG market have prompted companies to invest about $120 billion into the potentially lucrative business so far, according to independent research and advisory firm Lux Research.

In one of the most advanced LNG export projects, energy transport giant Williams Partners boosted natural gas supplies to Cheniere Energy Partners' Sabine LNG plant in Louisiana. Sabine, expected to enter service in late 2015, has an initial project capacity of approximately one billion cubic feet of natural gas per day. That kind of demand could be a significant factor in gas pricing. If the seven currently permitted LNG facilities process an average 800 million cubic feet of natural gas a day, their total usage would equate to over 30% of current inventory fill.

Who would benefit?
Sustainable higher natural gas pricing, due to depleted inventories and increasing demand, might finally help boost North American drilling activity -- a circumstance that would surely help the oil and gas service industry. 

Baker Hughes
Baker Hughes, one of the leading providers of oilfield services and products worldwide, would benefit from a revival in North American natural gas drilling. While the company posted excellent recent quarterly results, with revenues increasing 10% and share earnings jumping 28% year-over-year, much of the gains came from overseas.

The company's international business saw sales increase 13% and profits rise 29% versus a year earlier, while North American sales grew a slight 7%, though adjusted profits rose a more impressive 22% due to efficiency gains. Since roughly half of total company sales come from North America, any increase in regional natural gas exploration would add to Baker Hughes' admirable international performance.

The service provider's shares, valued at around 11.8 times trailing adjusted cash provided by operations, look somewhat attractive when compared to industry leader Schlumberger Ltd. at 14.1 times operating cash flow or peer Halliburton Company at 12.7 times. But evidence of U.S. natural gas drilling growth might make Baker Hughes stock significantly more appealing.    

National Oilwell Varco
National Oilwell Varco, a well-respected oil and gas drilling equipment and service supplier, would also gain from increased natural gas exploration. Though much of the company's business relates to offshore activities, a sluggish onshore North American drilling environment has held back results.

In the most recent quarter, companywide revenues increased 9% and net income jumped 17% compared to last year, mainly due to gains in the company's internationally based rig technology division. The company's services & supplies segment, which accounts for over 30% of total sales and remains closely tied to North American rig counts, saw its sales grow a weaker 5%.

A substantial improvement in North American drilling may be what's needed to push National Oilwell shares higher. Valued at around 10.7 times adjusted operating cash flow, the company appears moderately discounted to sector peers. Unexpected revenue or profit growth from greater than anticipated onshore drilling activity could close that valuation gap.

Superior Energy Services
Superior Energy might have the most to gain from an U.S. natural gas drilling resurgence. The company's recent quarterly results were disappointing. Revenues fell around 2% and income from continuing operations was cut by nearly half year-over-year. A 7% drop in U.S. land-based sales seemed to overwhelm other area gains.

While company management attributed some of the shortfall to extreme winter conditions, it is unclear how much of the miss was weather-related. Weak performance in Superior's major onshore business segments could also be related to larger competitors becoming more aggressive in a saturated market. Since about 64% of total company revenues are U.S. land-based, competitive positioning is a serious investor consideration.

An improved U.S.-based drilling environment could provide Superior Energy shareholders a meaningful gain, however. Currently valued at around 6.1 times trailing cash provided from operations, it appears little good news is priced into the shares and any unexpected pop in profits would probably be well rewarded.

Final thoughts
Low natural gas inventory levels and increasing demand look to support higher natural gas prices, which could finally boost natural gas exploration plans. Equipment and service providers like Baker Hughes, National Oilwell Varco, or Superior Energy might be big gainers if energy producers do put more pipe in the ground. Investors may find it worthwhile to keep an eye on natural gas rig counts. Any increase in the trend could be the signal for a possible drilling revival.

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Bob Chandler has no position in any stocks mentioned. The Motley Fool recommends National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco. 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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