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Irwin Michael on Natural Gas

I just listened to an audio interview with Irwin Michael and I totally agree with his position on natural gas.  Not only is natural gas undervalued compared to oil, but natural gas companies like Chesapeake Energy Corporation (CHK) and XTO Energy Inc (XTO) are undervalued in terms of their proven reserves.

By and large, we like the sector, we like oil, and we like gas.  Right now we prefer gas to oil.  There should be a relationship of 6 to 1 in terms of…the oil price should be 6 times natural gas.  Natural gas had gone up to about $15 per MCF, it is now trading at around $7.  So if you multiply by a factor of 6, oil should be trading at around $42.  Unfortunately, it’s trading at $66 a barrel US.  So it tells me that natural gas is relatively inexpensive to oil.  And that’s due to the fact that we are what we call in a shoulder season.  In other words, maybe not in Florida, but in the northern US states and in Canada, we are just coming off a fairly mild winter.  But nonetheless, the heating bills have started to go down.  So we are going to be using less natural gas.  And just prior to the warm summer season when you start using a lot of air conditioning and natural gas.  So they call this the shoulder season.  So this tends to be the bottom part of the natural gas price.  On a relatively basis, we think natural gas is undervalued.  By the way, heaven help us if we get some terrible hurricanes where you start knocking off some of the natural gas supply in the Gulf of Mexico.  The bottom line is we like oil and gas, right now we prefer natural gas companies and we are presently buying them.




By Theo at 2006-04-08 23:45 | Stocks | CHK | Theo's blog


Canadian Gas Companies - Help!

 I'm curious tho find out if anyone knows of any high quality canadian natural gas companies  or trusts they could recommend.   After reading the article, talking with Suntzu, and perusing the 2 year chart, I'm fully convinced of the half price sale currently going on in the natural gas sector.  My problem is that I don't know how to value natural gas stocks or trusts.  Please advise...
By sharpsicle at Mon, 2006-04-10 01:05 | login or register to post comments

Playing The Field

Sharpsicle,

Income trusts and common stocks are different animals and are analyzed in different ways. I think there are some common themes that should be part of your screen before you get into company specific analysis and, of course, you have to do your own DD. My thought on the natgas market go like this:

Unlike oil, natgas is a regional market so the focus should be on North American producers and explorers. The hurricane threat in the Gulf of Mexico could put upward pressure on the price of gas, but it doesn't help if your company's production is shut in. So companies with production in the Gulf should be avoided. Companies with production overseas will not be rewarded with the price spike North American companies would see if natgas spikes. To make analysis easier, let's break the companies into producers, explorers and trusts.

Producers

To get maximum leverage to a rise in the price of natgas, the company should not be hedging production. Companies with large debt are often required to lock in production at a certain price to satisfy the lenders that there is sufficient cash flow to cover payments. This is great for the lenders and not so great for the equity holders. What good is a price spike if the company has already locked in a lower sale price?

Explorers

Of course, these guys are lottery tickets. If they hit gas, the company soars. If they don't, they tank. One thing to look into is the company's drilling program. Aside from the obvious what, where, when questions, a good question to ask about is whether they have rigs booked. There is a huge shortage of drilling rigs in North America right now. What good is a promising land package if you can't drill it?

Income Trusts

Three words: pay out, depletion, management.

Pay out

Is the pay out sustainable? Will it rise with higher prices? Is it trading at a discount or premium to peers? Why?

Depletion

Are they replacing reserves? How? Are they diluting shareholder equity to do it? Are they paying too much?

Management

The quality of management is as important in an income trust as a common stock. The other thing to look at is the management agreement between the trust and the underlying company. Some of these are nothing short of robbery.

I hope this helps you get started. Please share your findings at the next Roundtable!

Suntzu


By Suntzu at Sat, 2006-04-15 14:00 | login or register to post comments