This post is for swing traders and investors interested in
playing U.S. natural gas production companies. I chose to focus on producers as
they have the most trading excitement due to their exposure to the volatility
of the price of the underlying commodity, exploration risk/reward and more
recently, due to their potential as acquisition targets.
Here are some fundamental factoids.
Natural gas:
+ is a necessity – it is
used to generate 20% of our electricity and heats more than half of our
homes
+ is trading near long term
low prices
+ is abundant in North
America and around the world – there is oversupply given current demand
+ can be a transportation
fuel – particularly for intra-city fleets
+ production and consumption
is increasing in the US and around the world
+ burns cleaner than oil and
coal and may benefit from new environmental/climate regulations
The following charts show how U.S. natural gas production and
consumption is growing, with gas rivaling coal in terms of heat content
produced and used within the country.
More than any other factor, the stock price of natural gas
producers is driven by the price of natural gas. Note that there has been a significant
recovery from the August-September 2009 lows of less than $3/million Btu, when
gas storage capacity was almost completely filled. But the current price of
$5.50/MMBtu is still well below the $13 peak of July, 2008. A return to $7-8/MMBtu gas does not require
too much of an imagination.
Looking at stock price charts of natural gas exploration and
production companies the commodity price driver is plainly evident, but it is
also possible to discern the effects of events such as major new discoveries
and M&A activities.
As an example of price driven by drilling success, McMoran
Exploration Co. (MMR) made a major new discovery on its Davy Jones prospect and
the stock responded favorably when the news was announced in January, 2010.
XTO Energy (XTO) gained 17% the day Exxon Mobil announced
its intent to acquire the company in December, 2009. As the deal was in stock,
it has subsequently fallen along with the price of XOM.
Brigham Exploration Co. (BEXP) is a textbook example of a
company producing both gas and oil in a hot play, in this case the Bakken of
North Dakota, with both oil and gas production.
BEXP has almost regained its 2008 highs, in no small part due to the
recovery in oil prices.
My current favorite pick among US natural gas producers is
Sandridge Energy (SD) which has discovered an enormous gas resource base in the
West Texas Overthrust area and has become recently more oily with its
acquisition of Forest Oil producing properties in the Permian Basin to the
north. This summer, a gas processing
plant developed in partnership with Occidental Petroleum (OXY) will be
completed. The gas plant will separate the natural gas (methane) from the CO2
that is produced along with it. The CO2 will be used for enhanced oil recovery
in mature fields in the Permian Basin. With a modest $1.5B market cap and
reserves that would be material to a major oil company, it makes an attractive
acquisition target.
But what I really like about SD is its chart and the firm
horizontal base (green line) that has been providing consistent support at a
little above $8 since April, 2009. I also like that the stock price did not
significantly weaken during the August-September 2009 gas price lows. Some of you may interpret this as a head and
shoulders pattern, but given the limited recovery of SD since the 2008 crash,
it is hard for me to consider this a classical topping pattern.
A move off this now ten month-old base could be powerful, so
I have been a buyer when it gets near this important support line. The daily chart indicates the possibility of
a double bottom forming off this support. Next week’s action will confirm or
reject the double-bottom hypothesis. On this chart, it is easy to see how with
a positive catalyst, SD could trade over $14. Buying at $8 and selling near $10
could make a nice shorter-term swing trade.
