What happened

Energy stocks are absolutely crushing it. While oil and clean energy stocks rallied by double digits this week, natural gas stocks weren't too far behind. Here's how much some of the popular natural gas exploration and production (E&P) stocks had gained on Friday by market close:

  • Antero Resources (AR -1.87%): 7.6%.
  • Range Resources (RRC -1.95%): 9.7%.
  • Comstock Resources (CRK): 10.4%
  • Southwestern Energy (SWN -1.57%): 8.3%.

Things weren't much different with providers of oil and gas drilling services: Helmerich & Payne (HP -2.48%) and Transocean (RIG -3.11%) shares closed today up 9.9% and 10.2%, respectively.

A storm is brewing, literally, just as the latest numbers from the U.S. Energy Information Administration (EIA) suggest strong upside for natural gas prices.

So what

Natural gas prices were up 4.6% Friday, as of this writing, and have now rallied 13.5% this week. Prices haven't been this high since December 2018.

Two factors are sending them higher.

Two persons studying stock price charts on computer screens.

Image source: Getty Images.

First, the EIA's weekly natural gas report released on Aug. 26 revealed much lower-than-expected growth in domestic supplies. Inventories held in underground storage facilities rose by only 29 billion cubic feet during the week ended Aug. 20, with total natural gas supplies at the end of the week coming in 16.5% below last year's level, and 6.2% below the five-year average.

The low inventory has sown fears of a supply crunch, especially as we head into winter, when demand for gas is high. And that has sent prices of natural gas soaring.

To add to the fears, a hurricane headed toward the Gulf of Mexico has forced energy companies to evacuate, triggering fears of lower production from the region in the coming days. The threat is real, as the Gulf Coast accounts for almost 51% of the total natural gas processing capacity in the U.S., according to the EIA.

The potential drop in production at a time when demand is rising and existing inventory is already low was bound to drive natural gas prices higher and present the perfect opportunity for investors to pile into natural gas stocks, especially shares of companies already generating strong cash flows and strengthening their balance sheets while still trading cheap.

AR Chart

AR data by YCharts.

Antero Resources, for example, which is the fourth-largest natural gas producer in the U.S., repaid debt worth nearly $600 million in the first half of 2021 thanks to strong cash flows. Given the rise in natural gas prices, the company could easily repay another $400 million and bring down its total target debt to $2 billion this year, ahead of plans. Antero already projects significant free cash flow (more than $3.5 billion) through 2025, but that was before the ongoing surge in natural gas prices. If they sustain momentum, the company could end up with even higher free cash flows.

It's a common theme across the oil and gas industry: Most companies have been using the incremental cash flows coming from stronger oil and gas prices this year to repay debt and shore up liquidity to spend on capital projects as demand picks up.

That also bodes well for providers of drill rigs and drilling services as demand is directly correlated to drilling activity by E&P companies. Helmerich & Payne already boasts one of the strongest balance sheets in the industry, so it has the leeway to upgrade infrastructure quicker alongside demand, giving it an edge over competitors. Transocean continues to struggle with a heavy debt load, but the stock's prospects certainly look better with every rise in oil and gas prices.

Now what

Gas prices typically can be volatile, but lower production from the Gulf could potentially keep prices -- of both natural gas and natural-gas stocks -- high, especially if domestic supplies don't shore up in the meantime. Keep an eye out on EIA data and news from the Gulf of Mexico to know where your stocks could be headed.