What happened
Shares of natural gas plays Tellurian (TELL 0.56%), Centennial Resource Development (PR 0.52%), and Obsidian Energy (OBE -0.82%) were soaring on Tuesday morning, though they moderated to gains of 3%, 3.4%, and 11.4%, respectively, as of 1:20 p.m. ET.
Both oil and natural gas prices rose again, with natural gas making new yearly highs. Concerns over Russia cutting off natural gas supplies to Europe could be affecting the price of U.S. natural gas, as it competes with export prices, which are currently soaring. While oil prices are up, they are still well below their June highs. However, natural gas prices have already exceeded their price in the immediate aftermath of the Russia-Ukraine war, and touched new yearly highs of $10 per thousand cubic feet, before backing off in midday trading. In fact, that intraday high for natural gas was actually a new 14-year high.
So what
Each of the three stocks above is highly sensitive to natural gas prices. Tellurian is a highly levered bet on natural gas prices, since its main asset is the Driftwood liquefied natural gas (LNG) export plant, which will cost close to $13 billion to build and won't be ready for LNG conversion and export until 2026. As Tellurian raises money for the construction, it has also acquired some upstream natural gas production to generate some cash flow, recently buying EnSight, a Haynesville shale play that will increase its production by 30%. Therefore, Tellurian is highly dependent on robust natural gas prices now and through the end of this decade. So when natural gas prices are strong, Tellurian soars.
Both Centennial and Obsidian are smaller oil and gas drillers, with Centennial being a $2.25 billion market cap company concentrated in the Delaware Basin of the Permian shale, and Obsidian being an oil and gas producer with wells in Western Canada, with just an $840 million market cap. Both companies get close to half of their output from natural gas.
Both Centennial and Obsidian are also surging due to their extreme low valuation, as small-cap explorers and producers (E&Ps) tend to trade at lower valuations than their large-cap peers. Centennial only trades at 4.9 times earnings, and Obsidian trades around 5.4 times earnings, even after Tuesday's surge.
This could be because unlike their larger peers, neither company is paying dividends to shareholders yet, as they are still in the process of working down their debt loads left over from the pandemic. However, if oil and gas prices stay higher for longer, it's possible these stocks could appreciate more than the more mature dividend plays, given their low valuations and leverage to higher prices. On the other hand, their remaining higher debt loads in relation to their cash flows also makes them riskier.
Now what
While many investors tend to focus on the price of oil, most North American (E&Ps) have a more balanced output between oil and natural gas. While there has been widespread concern over the drop in oil prices due to the slowing economy, the potential cutoff of Russian gas supplies to the European Union could put a floor under natural gas prices this fall and winter. That means the earnings of U.S. oil and gas drillers could remain resilient, even if oil demand softens.
For those looking for higher-risk but higher-upside plays in the oil and gas space, these three stocks could be welcome additions. Just be aware that this sector can be highly volatile, and you won't be receiving the sky-high dividends that the larger U.S. shale players are currently paying.
