Natural Gas Stocks: Beware of Declining Natural Gas Prices

Natural gas prices have been trending lower on the back of increasing dry gas production in North America and reduced demand thanks to an unusually warm winter. Dry gas is landlocked in North America since there are no facilities to export it to world markets where in some cases can fetch prices upwards of $10/mcf compared to the $2 and change it currently sells for in North America. The supply build-up will only make things worse for natural gas weighted names and could potentially wreck havoc later this year among producers as they compete for depleting storage space. Canadian natural gas prices will suffer more pressure as they get bullied by rising US production competing for pipeline capacity. As of February 15, the EIA reported a decline of 19% in Canadian natural gas exports to the US compared to last year. Whether you’re a contrarian investor or a value investor looking for exposure to natural gas weighted producers, make sure you review the following variables.


too much supply, not enough demand!

Impact of Declining Gas Prices

The impact of declining natural gas prices is starting to be felt as natural gas weighted companies are forced to scale back capex programs which slows or reverses production per share growth. Companies that will fail to plan for a sustained level of price weakness will be lead to higher debt levels forcing dilution through potential equity financings or asset sales at what could be the low of the price cycle.

Wishful Price Decks

Many financial institutions and companies are still using pie in the sky average gas price estimates for 2012. As of last week, YTD average AECO Spot strip pricing has been $2.38/mcf and $2.60/mcf for Henry Hub Spot. Make sure you review what a company is budgeting for its natural gas production especially if it pays a dividend. A company’s cost structure is the key here, are they making any money at current prices? Are they even breaking even? Will they be able to break even if prices average $2 or less?

Plan B: Liquids

There’s no way to know where natural gas prices will settle this year or how long this depressed price environment will last, producers with a significant natural gas weighting should be shifting focus to oil or liquids production in order to strengthen cash flow. Failure to do so will result in a prolonged period of pain for shareholders or worse depending on the balance sheet health. Does the company have an inventory of low risk oil or liquids rich targets? Can the company achieve this shift within a contracting cash flow?


no surprise we have a glut…

Balance Sheet Health

Natural gas weighted companies that are currently drawn on their line of credit at levels higher than 70% or even less might be in for a nasty surprise. Banks will reduce their credit lines when current strip pricing is applied on their reserves resulting in more stress on operations and growth. This brings us to the balance sheet health, how much is the company drawn on its bank line and does it have a decent margin it could use to focus on increasing liquids production? Reducing capex and hunkering down until the storm passes neutralizes production growth which turns the company into dead money for investors.


For a heavily weighted natural gas producer, having 10% or even 20% of natural gas production hedged at higher prices for the year is in my opinion useless as the impact of the remaining 80% will strangle cash flow. A company with significant hedges in place will still feel the impact of low natural gas prices if their reserves are weighted to natural gas since the bank lines might suffer. This year, producers were caught with their pants down as I believe they were waiting for strengthening prices this winter to lock in their hedges, a winter that turned out to be extremely disappointing.


Finally, if you’ve read this far, it is obvious that I am bearish on natural gas. There’s just no hope until we close in on operational export facilities or unless some unexpected event changes the fundamentals of this commodity (fracking ban for example). However, if you are a contrarian investor or a value investor looking for exposure to gas weighed names, remember to  focus on companies with breakeven prices below current strip pricing without forgetting to take into account the remaining variables discussed above.  These are the companies that will survive and prosper in the long run once the price cycle reverses. Keep in mind that it might get worse before it gets better, timing is everything and hindsight is 20/20.

What do you think of natural gas prices?