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This Outlook Is Bad News for Natural Gas Stocks

By Matthew DiLallo - Updated Sep 16, 2019 at 6:59AM

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An abundance of natural gas could push its price down to the lowest level since 1970 next year.

This year has been another challenging one for America's natural gas producers. They've discovered so much low-cost gas that they've unleashed a torrent of new production in recent years, which has pushed down prices. While those lower prices have spurred new demand, output in the country continues to outpace consumption.

That means prices could be under even more pressure in 2020, according to a new forecast by IHS Markit. If that outlook comes to fruition, natural gas stocks, which have already tumbled in 2019, could have even further to fall in the next year.

A natural gas well with pipelines at sunset.

Image source: Getty Images.

Challenging times in the natural gas market

After averaging $3.15 per million British thermal units (MMBtu) last year, natural gas has declined this year. It averaged only $2.22 per MMBtu in August, which pushed its year-to-date average to $2.62 per MMBtu. That slump put pressure on the profitability of natural gas drillers, causing their stock prices to plunge:

AR Chart

AR data by YCharts

The primary factor weighing on the price of gas is too much supply. Natural gas companies have produced an average of 91.4 billion cubic feet per day (Bcf/d) this year, according to the U.S. Energy Information Administration (EIA). That's is up 8 Bcf/d or nearly 10% from 2018's total. While demand has also risen as new liquified natural gas (LNG) export facilities have come online, the industry is producing more gas than the market needs. That's causing excess gas to fill up the country's storage facilities, which is weighing on prices.

No one to blame but themselves

Despite lower gas prices, energy companies continue to drill more wells. As a result, production is on track to keep rising next year. In the EIA's latest forecast, output will increase another 2% to an average of 93.2 Bcf/d. Given that projection, IHS Markit forecasts that gas prices will drop to an average of $1.92 per MMBtu in 2020. That would be its lowest price since the 1970s.

One reason natural gas producers continue drilling is that they have spare capacity on pipelines to fill. That's because many signed long-term take-or-pay contracts for space on new pipelines. As a result, they pay even if they don't use it. That unused capacity can add up. In Antero Resources' (AR 4.98%) case, it will spend $260 million to $280 million next year on excess pipeline capacity. However, it has a plan to eliminate about $200 million of its annual underutilized pipeline expenses by 2022 by drilling more wells to grow its output. That strategy sets it up to generate $400 million in free cash flow in 2022, as opposed to nothing if it switched over to a maintenance mode in 2020. That's a lot of money for a company that currently has a $1 billion market cap as a result of its plunging stock price. Though the company's forecast assumes gas prices don't fall any further.

On one hand, Antero is somewhat protected against lower prices since it has hedging contracts in place that lock in the bulk of its gas sales over the next two years. For 2020, it has already contracted 90% of its output at $2.87 per MMBtu while it has hedges in place for 50% of its 2021 production at $2.75 per MMBtu.

It's rivals, however, aren't quite as well protected. Southwestern Energy (SWN 7.35%), for example, only has hedging contracts in place for 72% of its total output this year at an average floor price of $2.90 per MMBtu. Next year, it currently has 22% less of its production covered at a lower floor price of $2.70 per MMBtu. Range Resources (RRC 8.01%), meanwhile, currently has 65% less output under contract for next year than it will have during the fourth quarter of 2019. Furthermore, its contracts lock in a slightly lower price than this year's average.

Those producers will feel the sting of lower prices if IHS Markit's forecast comes to fruition. That would probably put even more pressure on their already beaten-down stocks in the coming year.

Another tough year awaits

Natural gas producers continue drilling despite lower prices. That's because many have to since they need to fill up unused pipeline space.

On one hand, the country will eventually need more gas as additional LNG projects coming online over the next few years. In the near term, however, the incremental output will add more supply to an already oversaturated gas market. Prices could therefore be even lower next year, which suggests that 2020 could be another brutal year for natural gas stocks.

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Stocks Mentioned

Southwestern Energy Company Stock Quote
Southwestern Energy Company
SWN
$7.01 (7.35%) $0.48
Range Resources Corporation Stock Quote
Range Resources Corporation
RRC
$26.29 (8.01%) $1.95
Antero Resources Corporation Stock Quote
Antero Resources Corporation
AR
$32.27 (4.98%) $1.53

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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