What happened

Shares of several natural gas stocks rallied more than 10% this week. Leading the charge were Tellurian (NYSEMKT:TELL)Range Resources (NYSE:RRC), and Comstock Resources (NYSE:CRK), which jumped between 10% and 16% since last Friday. Surging natural gas prices fueled a rally in the sector. 

So what

The price of natural gas hit a seven-year high earlier this week, with U.S. gas futures closing at $5.46 per MMBtu on Wednesday. Meanwhile, natural gas prices in Europe and Asia traded near $23 and $19 per MMBtu, respectively. 

Liquified natural gas storage containers at a port.

Image source: Getty Images.

Several factors fueled the surge in natural gas. For starters, inventory levels are below normal in the U.S. and Europe ahead of the winter heating season due to strong export demand and lower production over the past year because of the pandemic. Meanwhile, hurricanes in the Gulf of Mexico knocked some production offline, which has been slow to resume. They also forced an LNG export facility to shut down, which is finally starting back up. On top of that, another LNG export facility is undergoing maintenance that will shut it down.  

These market issues highlighted the country's need for more natural gas production capacity, sending shares of natural gas companies higher. For example, the LNG market issues highlighted the need for Tellurian's proposed Driftwood LNG facility. The company has been working toward making a final investment decision on the project, which is increasingly likely given the recent spike in gas prices and the growing global need for the fuel. 

Meanwhile, higher natural gas prices will benefit producers like Range Resources and Comstock Resources. Higher gas prices buoyed Range Resources in the second quarter, enabling the company to generate $120 million in free cash flow. It used those funds to help reduce its total debt by $66 million, helping firm up its financial foundation. With gas prices continuing to rally since then, Range should generate even more free cash flow, further improving its financial flexibility. It also has a large inventory of future drilling locations, positioning it to increase its production if the market needs more supply in the future. 

Comstock Resources is also benefiting from the improvements in the natural gas market. It generated $53 million of free cash flow during the first half of the year. The company's free cash flow and improving market conditions are making it easier for Comstock to finance its business. The company was able to refinance 9.75% senior notes with new 5.875% senior notes in the second quarter, saving it $28 million in annual interest payments. Combined with even higher gas prices, those interest savings position Comstock to produce even more free cash in the coming quarters. That could give its stock even more fuel to keep rallying.

Now what

The past several years have been tough for natural gas producers as they battled oversupply and weak pricing. However, things are starting to look up for the sector as gas prices are at the best level in seven years due to lower inventory levels and hurricane-related supply issues. That positions gas producers to generate a gusher of free cash flow, which they can use to bolster their balance sheets, putting them in a stronger position to weather future market volatility.

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