For four years now, North American natural gas has been basically a short sale. But every commodity price cycle eventually turns. When most least expect it, low prices spur demand and limit supply enough for prices to bottom, just as high prices eventually bring on production and encourage conservation to force a top.
Not surprisingly, after the shellacking all things gas have taken in recent years you’re not going to find a lot of bullish investor opinion on natural gas these days. In fact, oil and natural gas liquids (NGL) have now joined gas on the downside.
Until today’s USD6 per barrel surge, West Texas Intermediate crude had been bouncing under USD80 a barrel after trading well above USD100 just a couple months ago. And prices of NGLs such as propane and ethane, widely used as substitutes for petrochemicals, have tumbled even more.
Events this week in Canada, however, should make value-focused investors think twice about selling their energy patch stocks just yet.
It’s actually time for everyone to take a second look at gas, particularly anyone looking for solid dividend-paying stocks.
To be sure, the past few years’ exploration and development of gas from shale has left supplies well in excess of current demand. That’s true even with hot weather in much of the country making up for the mild winter, and electric utilities converting massive portions of their generating fleets to gas.
Meanwhile, the massive investment needed to enable exports of natural gas is only now getting underway.
Though the price of gas in Asia and Europe is multiples higher than in North America, it’s going to be several years before there’s any possibility of meaningful arbitrage and any leveling out of prices around the world.
That means gas prices are likely to remain low here for some years. And in the meantime, producers will be doubly challenged by volatility in oil and NGLs, which, like dry gas, are headed for a quantum leap in demand but only after major investments are made in chemicals plants and export capacity.
Markets, however, always anticipate the future rather than reflect the past. And few events are better forecasters of value than well-timed takeovers–in the case of natural gas, the acquisition of Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF) by Malaysia’s national oil company Petroliam Nasional Berhad, better known as Petronas.
Oil is a key underpinning of the Malay economy, and Petronas has used its strength at home to build a global portfolio of assets. But the CAD5.5 billion bid for Progress Energy is a whopping 77 percent premium to the stock’s pre-announcement market price.
This not only demonstrates Petronas’ deep pockets. It also signifies management’s deep appreciation of the value of Progress’ assets, which is certainly based on intelligence gained from the pair’s current partnership to develop gas assets.
The CAD20.45 per share paid is the highest price hit by Progress since mid-2008, when gas was still well over USD10 per million British thermal units.
Petronas’ purchase is part of its larger strategy to export Canadian gas to Asia. That includes the construction of an export terminal for liquefied natural gas (LNG) and related infrastructure.
The target date for the facility to open at this point is 2018. That implies a lot of years of continuing to depend on the US market, where more than 60 percent of Canadian gas is still sold.
But the handwriting is on the wall: Deep-pocketed investors with very long-term time horizons have zeroed in on the value in North America’s energy patch.
At a minimum, that puts a limit on how far stocks of energy producers will fall during this cycle. Volatile energy prices mean these stocks will have their ups and downs–and there are almost certain to be more dividend cuts as well, particularly when oil and NGLs prices dive on global economic concerns.
Consequently, a conservative approach is best in picking dividend-paying energy producers.
Best protected in the current environment are companies that have hedged most or all of their expected production for the next several years, pay out a relatively low percentage of available cash flow, have relatively undrawn credit lines and relatively little maturing debt, and can boost production economically at today’s gas price.
When North American gas prices do rise to reflect higher global prices, conservatively run outfits will benefit as much as weaker long shots. In fact, odds are they’ll only grow more powerful in coming years at their rivals’ expense, grabbing high value reserves and production from distressed owners.
Meanwhile, they’ll continue to pay generous distributions as we wait.
Best of all, momentum-focused investors have sold off conservatively run North American energy producers nearly as aggressively as they have weaklings, so values abound.
Vanguard Natural Resources LLC (NYSE: VNR), for example, now yields better than 9 percent, despite increasing its payout six consecutive quarters. It’s also eliminated much exposure to volatile energy prices with hedging and continues to make acquisitions–including a CAD445 million deal announced earlier this month.
In Canada there are several very high-quality candidates for another Progress-type takeover. ARC Resources Ltd (TSX: ARX, OTC: AETUF) has a portfolio of reserves that are at least as impressive as those owned by much smaller Progress. And despite a nice pop in the wake of the Progress deal, it’s still down by nearly 10 percent this year.
Pipelines and energy infrastructure is another sector whose value has been vindicated by the Progress takeover. Panicky momentum-followers have unloaded many of these companies–both Canadian dividend payers and US master limited partnerships (MLP)–on overblown worries about falling oil and NGLs prices. And as a result bargains abound in the sector.
We highlight the latter in the upcoming issue of our MLP Profits advisory, which will go to post next week. I’ll be looking at the Canadian beneficiaries of the Progress deal in the July Canadian Edge, which goes to post a week from today.
And note that the July Utility Forecaster will be up at www.UtilityForecaster.com tomorrow morning, along with more energy sector favorites.
Whatever you do in energy, make sure you’re focused on value, not market momentum that’s being led by dozens of what are mostly irrelevant factors.
However scary the political and so-called economic headlines are, this market is still following the course of 2010 and 2011. And as long as that’s the case, the currently gloomy mood will shift again later this year, turning what’s now selling momentum into buying momentum.
That means the same stocks getting beaten up now on overblown fears of what might happen are likely to be the biggest winners going forward.
And so long as they hold together as businesses, buying or at least holding is the only sane course.
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