With oil hovering around $100 per barrel, and natural gas still below $5 per thousand cubic feet, or mcf, it's hard to love natural gas. However, that might be just the place to look for a bargain. As investors, we should always be on the lookout for what might go up in the future, not necessarily what has already gone up.
There are a few ways to benefit from a future increase in natural gas. For starters, you might buy high-cost producers such as Oasis Petroleum (NYSE: OAS) or Petroleum Development (Nasdaq: PETD). If natural gas spikes upward, these companies will gain the most, allowing investors to benefit from operating leverage in the way of high fixed costs.
The problem with the high-cost strategy is that these companies may go bust if natural gas prices stay low for long enough. After all, exploration and production companies need to constantly sell the oil and gas they pull out of the ground. At low prices, high-cost producers are paying more to pull the stuff out of the ground than they can receive by selling it.
Enter the low-cost end of the spectrum -- the safer alternative. Despite persistently low natural gas prices, low-cost producers have stayed solidly profitable. One of the leaders in the low-cost category is Ultra Petroleum (NYSE: UPL). In 2010, Ultra averaged all-in costs of $2.68 per mcf, which compares favorably to the mean of $5.62 per mcf. We've established that Ultra has low costs, but just how cheap is it?
Let's compare its operating cash flow to that of its peers:
|
Company |
Trailing Cash Flow From Operations* |
Market Cap on July 22, 2011* |
Market Cap / CFFO |
|---|---|---|---|
| Ultra Petroleum (NYSE: UPL) | $841 | $7,240 | 8.6 |
| Chesapeake Energy (NYSE: CHK) | $4,675 | $21,824 | 4.7 |
| Southwestern Energy (NYSE: SWN) | $1,621 | $17,047 | 10.5 |
| Encana Corporation (NYSE: ECA) | $3,841 | $21,294 | 5.5 |
Source: Capital IQ, a division of Standard & Poor's.
* In millions.
Looking at the above table, one would probably not consider Ultra the best value. However, that would be selling this company short. A look at its operating history is necessary in order to properly judge this company.
Over the last five years, Ultra has increased its proved reserves at 17% annualized and its production at 24% annualized. Coupled with its extremely low all-in costs, this company possesses a winning combination. While many other companies have to adapt and react to the constantly changing business of oil and gas exploration and production, Ultra can simply keep doing what it's done over the last five years.
With over 10,000 drilling locations staked out, Ultra already has plenty of land to develop. Over the next three years, management expects to further increase production growth by 50%. Based on Ultra's performance over the past five years, that seems like a high-probability bet.
Interested in Ultra Petroleum? Add it to your Foolish watchlist.
