There are numerous ways to invest in an eventual recovery in natural gas prices. One way is by buying pure-play natural gas producers, such as Ultra Petroleum (OTC:UPLM.Q), Southwestern Energy (NYSE:SWN), or Cabot Oil & Gas (NYSE:COG). All three are extremely low-cost natural gas producers that can turn a profit even with gas prices below $4 per Mcf, which limits their downside from continued stagnation in gas prices.
But these companies have extremely limited liquids exposure and offer little to no upside if gas prices remain stuck within their current range of $3.50 to $4 per Mcf over the next few years. While there are good reasons to believe this won't be the case, there's obviously no way to say for sure. That's why investors would do well to consider Devon Energy (NYSE:DVN), a company that offers both a robust liquids production growth outlook and tremendous upside optionality from a recovery in gas prices.
A robust liquids-rich portfolio
While many investors probably still view Devon as a gas-heavy company, I don't think that's any longer a fair assessment. Liquids now represent 43% of companywide production, up from 37% a year ago, with oil sales accounting for nearly 60% of total upstream revenues. This drastically improved commodity mix is largely due to the company's rapid growth in oil production, which has surged from 106 million barrels per day in 2010 to 146 million barrels per day last year -- pretty impressive for a company of its size.
This growth shows no signs of slowing down, either. In the third quarter, companywide oil production grew 16% year over year, averaging 165,000 barrels per day, led by solid results from the company's Permian Basin and Mississippian-Woodford Trend projects. During the quarter, production volumes in the Permian rose 7% sequentially to a record 82,000 barrels of oil equivalent per day, while Mississippian/Woodford volumes surged 66% to 9,000 barrels per day.
Going forward, Devon plans to direct the majority of its capital budget toward liquids-rich plays, such as the Permian, Cana-Woodford, the Mississippi Lime, and the Athabasca oil sands in Alberta, which should continue to deliver robust production growth. The company expects total production in the fourth quarter to average between 680,000 and 700,000 BOE per day, which puts it on track to meet its 2013 target of 250M-254M million BOE.
Gas upside optionality
At the same time, however, Devon retains plenty of upside optionality to a longer-term recovery in natural gas prices, thanks to its massive stake in the Barnett shale, where it commands over 600,000 net acres, as well as gassy acreage in Canada's Horn River Basin, Texas' Carthage region, and other plays across North America.
While Devon is currently only drilling in the liquids-rich regions of these plays, much of its acreage is held by production, which gives it plenty of room to curtail or accelerate dry gas drilling as it sees fit. If gas prices were to rise above a certain level, the company could easily divert capital to the Barnett and other plays to boost gas production.
The bottom line
Even though there is good reason to believe that natural gas demand will outpace supply over the next several years, fueled by demand from utilities, energy-intensive manufacturers, LNG exports, and possibly even the transportation sector, leading to an increase in the cleaner-burning fuel's price, there's obviously no way to be sure.
That's why I believe Devon provides one of the safest ways of investing in a long-term recovery in gas prices, while keeping downside limited thanks to its enviable portfolio of liquids-rich assets. It also boasts a rock-solid balance sheet, a disciplined management team with a history of returning cash to shareholders, and an attractive valuation, all of which make it an excellent buy-and-hold stock in my opinion.