This perception of the price advantage of natural gas has some states reviewing legislation passed in those states late last decade requiring investments in wind, solar, and similar non-fossil fuel production. Led by the American Exchange Council (“ALEC”) and other right wing groups, states such as North Carolina and Texas are the leaders in that movement. Yet, the presumptions that natural gas is both cheap and clean are debatable.
Natural gas is a fossil fuel, and while its burning typically involves about half the release of carbon that coal burning emits, natural gas’ carbon footprint is still considerable. But more important, perhaps, is the amount of methane that is released upon drilling or fracking for natural gas. Methane is a far more potent greenhouse gas than is carbon, and attempts to study the overall heat trapping footprint of coal and gas find that gas’ advantage is modest at best.
If natural gas is not going to singlehandedly protect the environment, at least we will have a secure local supply of energy for the next 100 years right under our feet, right? No so fast. A detailed, 181 page report released earlier this year argues persuasively that natural gas development physically cannot create energy independence in the United States. Well, at least natural gas is cheap. Never mind that it has risen from about $1.80 per mmBTU in April, 2012 to about $4.30 per mmBTU 54 weeks later. Increased utility scale use and homogenization of world prices will auger in higher prices in the future, at a time when many billions of natural gas infrastructure have already been spent.
The natural gas producing companies have benefited mightily from the price run-up. But many remain overleveraged in what is still a low natural gas price environment. The leading company, both in terms of sales and headlines the past few years, has been Chesapeake Energy Corporation (NYSE:CHK). Over the past five years, amid self-dealing by then Chief Executive and President Aubrey McClendon, earnings have collapsed by an average of nearly 30% annually. But, with the price of natural gas on the rebound to prices not seen since summer of 2011, Chesapeake Energy Corporation (NYSE:CHK) should at the very least be profitable. The company is a shell of its former self after having divested over $10 billion in assets last year to deal with its long term debt problems. And it is not done yet, with plans to sell from $2.5 to $5.5 billion more this year.
Chesapeake Energy Corporation (NYSE:CHK) has reversed course on its disastrous decision in 2011 to leave unhedged its gas production. As luck would have it, it has locked in about 50% of its expected 2013 gas production at a price of $3.62 per mmBTU. As indicated above, gas has been selling at the Henry Hub open market price in excess of $3.62 since early March, and I do not see the price collapsing. The bottom line is that while Chesapeake Energy Corporation (NYSE:CHK) may well have a pretty good year, it likely will not be as profitable as it could be due to the hedging. Analysts are expecting $1.31 per share this year and $1.81 per share in 2014, compared to the $0.61 posted in 2012.
There are still a lot of unknowns, though related to asset sales and management changes. Until these settle down, I would still be on the sidelines of this otherwise solid turnaround story.
The one natural gas producer that I can endorse without much reservation is Cabot Oil & Gas Corporation (NYSE:COG). Its first quarter earnings came to $52.4 million, or $0.26 per share, versus expectations of $0.24 for the quarter and $0.14 per share a year ago. Revenues came to $373 million, up from $272 million a year ago, based upon a 50% increase in natural gas production from the year earlier quarter. As the second quarter unfolds, Cabot Oil & Gas Corporation (NYSE:COG)’s numbers will look even better due to a greatly improved price climate for gas versus the second quarter of 2012. In all, I look for the company to double its profit from 2012, to about $1.30 per share for all of 2013.
My slight hesitation here has to do with valuation. At that $1.30 per share number, Cabot Oil & Gas Corporation (NYSE:COG) is trading with a price to earnings ratio of nearly 40. But if, like me, you see future increases in natural gas prices, Cabot Oil & Gas Corporation (NYSE:COG) is set to develop top tier top and bottom line performance in the year ahead. Its PEG is a modest 1.31, and I like this company a lot over the next one to three years.
Elsewhere in the natural gas world, things are far more bleak. Once proud EnCana Corporation (USA) (NYSE:ECA) is burdened by having overspent for property and equipment prior to natural gas’ price plunge. Having to write off a portion of those investments of $431 million in the first quarter of this year led to a GAAP loss for the quarter. But even omitting that largely non-cash charge from the equation, EnCana Corporation (USA) (NYSE:ECA)’s earnings in the first quarter came to $179 million, or $0.24 per share, compared to $240 million, or $0.33 per share a year ago. Despite the vastly improved price profile for natural gas this year versus last, EnCana Corporation (USA) (NYSE:ECA)’s fixed costs will doom it to a year where its profits are unlikely to approach last year. I would absolutely avoid EnCana Corporation (USA) (NYSE:ECA).
Similarly, shares of Southwestern Energy Company (NYSE:SWN) are unlikely to anytime see the $50 plus level it traded at in 2008. One problem with this company is that its earnings were not all that bad last year. Therefore, there seems to not be as much room for improvement in 2013 and 2014 as we find in other natural gas plays. Southwestern Energy Company (NYSE:SWN) cleaned up its asset base by taking $1.2 billion write-offs in 2012. All through the year, though, its underlying business performed well in the low price environment, as adjusted profits were $485 million, or $1.39 per share, down from $1.82 in 2011. The company will not release earnings for the first quarter until early May, and I look for quarterly earnings up 12% to 15% for both the quarter and full year 2013, on an adjusted earnings basis. There are more rewarding prospects elsewhere.
The article Natural Gas – An Industry in Peril? originally appeared on Fool.com and is written by Bill Edson.
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