The U.S. shale industry is absolutely crushing it right now. Pipelines across the country are operating at maximum capacity because oil and gas production growth has outstripped the pace of pipeline expansion. OPEC and its allies have again pledged to reduce their output in an effort to avoid a glut due to the United States' swelling energy exports. Domestic production growth is expected to continue for the foreseeable future.
That's sure to create opportunities for Antero Resources (NYSE:AR), which is one of the leading producers of natural gas and natural gas liquids (NGLs) in the Marcellus and Utica shales. The two -- collectively called the Appalachia region -- were responsible for 41% of all shale gas produced in the country in 2017, and are expected to help the Northeast region double its natural gas output by 2022.
However, as Antero Resources' 34% share price slide since the beginning of 2018 hints, the business faces notable obstacles, too. Should investors looking to add a leading shale energy stock to their portfolios consider it a buy today?
The bull case for Antero Resources
Business is booming for Antero Resources. Through the first nine months of 2018, revenue grew 17% compared to the prior-year period, while operating cash flow grew 33% (excluding a one-time favorable hedge position from 2017). However, operating income fell 79% year over year as non-cash asset impairments for unproved properties grew from $83 million to $406 million. That may seem alarming, but both totals were the result of writing off sites in the Ohio Utica shale that are not currently in the company's development plan.
More importantly, the reason to write off unproved properties is that doing so shifts the focus to proven resources in the company's most valuable acreage. In the third quarter, Antero Resources brought a record 73 new wells online. Even without a full quarter of output from those new assets, the company hit a quarterly production record of 2.7 billion cubic feet per day (Bcfe/d) of natural gas equivalent, and 129,352 barrels per day of liquids.
Fully 92% of the liquids produced were NGLs -- the bread and butter of its business, and the key value driver for investors to consider. For instance, Antero Resources reported an average selling price for natural gas of $2.95 per thousand cubic feet, but that average jumps 25% to the equivalent of $3.70 per thousand cubic feet when NGLs are included.
Given the market's growing appetite for both NGLs and natural gas, which will fuel America's growing petrochemical manufacturing industry and pump up its energy exports in the coming decade, Antero Resources is well positioned for long-term success. After reporting that operations hit a production level of 3 billion cubic feet per day equivalent in October, management now expects the fourth quarter to represent an inflection point on the free cash flow generation front. That will provide around half of the $600 million it expects to spend on its share repurchase program over the next few years.
The bear case for Antero Resources
Natural gas producers have simply not been great investments in recent years. Unfortunately, Antero Resources finds itself among the downtrodden: shares have lost 81% of their value in the last five years. How can that be given the operational improvements?
Well, one of the biggest problems is that natural gas infrastructure -- pipelines, petrochemical manufacturing facilities, and even natural gas power plants -- always seems to lag behind natural gas production potential in the Northeastern United States. That keeps natural gas prices relatively low and margins thin.
While infrastructure expansion has the potential to relieve some of the regional supply glut in the years ahead -- Royal Dutch Shell's upcoming world-class ethane cracker in Western Pennsylvania, new natural gas power plants, and more pipelines to carry product to the Gulf Coast among them -- investors have been hearing that argument for almost 10 years now with little progress to back up the talk.
The wild card here is that Antero Resources does have the most liquids-rich acreage in the region. That bodes well for its potential to deliver some of the best margins in the region, especially if new petrochemical manufacturing facilities result in a significant increase in NGL demand, but investors may want to take a "show me" approach before blindly believing this time will be different.
This natural gas stock could go either way
It may not be a household name, but Antero Resources is playing a key role in America's growing energy dominance thanks to some of the most valuable acreage in the Appalachian shale regions. Management expects growing production volumes to allow the business to hit a key inflection point as it exits 2018: generating healthy and sustainable amounts of free cash flow. The expectation is that much of that will be returned to shareholders.
That said, the business has simply not been able to translate production growth into shareholder value in recent years. A chronic mismatch between natural gas production and infrastructure has made the American natural gas industry a victim of its own success. While natural gas will become increasingly important to domestic and international affairs, it's not yet clear that will create successful outcomes for upstream producers such as Antero Resources.
With the stock down 40% since the beginning of 2018, investors with an appetite for risk may be willing to start a small position in Antero Resources. For all other investors, it may be better to sit on the sidelines and wait for the company's strategy to gain traction before deciding to jump in.