Residents of on East Coast of the U.S. are surely eager for spring to arrive after what has been a brutal winter. It seems like every week we are digging out from a new batch of snow. While the Polar Vortex has the mercury dropping, things are heating up elsewhere: in the natural gas market.
Cold weather led to a spike in demand for heating, which means higher consumption levels of natural gas. The surge in demand was reflected in price levels, with the Henry Hub spot price briefly surpassing $8 per million Btu (MMBtu). Local markets fared even worse – spot prices for day-ahead wholesale in the Alogonquin Citygate hub (Boston) blew past $22/MMBtu. Prices in New York were similarly painful. These areas suffered because of inadequate pipeline capacity – bottlenecks that gouge the consumers in the Northeast.
Figure 1 Source: EIA
By all accounts, this is a temporary phenomenon. Spot prices for Henry Hub dropped down to around $4.80-$4.90/MMBtu in the last week of February as temperatures eased, more than $1 cheaper than the prior week. So, we will return to business-as-usual.
But, what will natural gas prices look like for the rest of the year? While we may not see Henry Hub go back above $6/MMBtu anytime soon, the winter of 2014 may have marked the end of cheap gas as we knew it. The “shale gas revolution,” we were told time and time again, ushered in an era of cheap and abundant gas that would last for years. While that may be true as far as it goes, natural gas prices were unsustainably low for quite some time.
Gone are the days of sub-$2 gas, which we saw in the spring of 2012. Natural gas prices are now more than double those levels. Even before the harsh winter, natural gas prices had reached their highest levels in four years. And the drawdown in inventories likely means that prices are not going to suddenly drop precipitously from the $4.80-$5.00 range. Underground storage of natural gas dropped by 250 billion cubic feet in the last week of February to its lowest level since May 2008. This suggests that supplies will remain tight this year. Futures contracts are showing prices near $5/MMBtu for the next several months. Citigroup sees the same thing – it recently revised upwards its projection for average natural gas prices in 2014 to $5/MMBtu.
So what? Well, the shale gas story had grown to be old news, with the “Bakken Blitz” stealing the headlines over the last year or two. But companies that decided to cut back on drilling during a period of low prices will return to the gas patch. And companies that were already able to profitably produce when prices were below $3/MMBtu will now make even more money. While everyone is talking about tight oil, here are a few companies that can quietly make you some money over the rest of this year.
If you want to go with the big boys, ExxonMobil (NYSE: XOM) is an obvious choice. I won’t spend too much time talking about them because they are so well known, but as the largest producer of natural gas in the country, they stand to benefit from higher gas prices.
A more targeted shale gas producer would be Cabot Oil and Gas (NYSE: COG), a major player in the Marcellus Shale. Cabot has a market cap of $14.79 billion and a dividend of $0.08 per share. It also has some of the best operations relative to its peers. Cabot has an average EUR of 16.9 billion cubic feet per well, which is up 20% from its 2012 average. It can also get more gas out of a single lateral than anyone else in the Marcellus – 3.6 Bcf per 1,000 feet, which is 21% higher than its closest competitor. Cabot increased its proven reserves by 42% last year. Most importantly, Cabot was pulling in great returns even before natural gas prices went up. It had rates of return above 100% at $3/MMBtu. Moreover, new pipelines are underway in Pennsylvania to help offload Cabot’s product, which will be a boon over the long-term.
Another company well positioned in the gas patch is Gulfport Energy (NASDAQ: GPOR), an oil and gas driller in the Utica Shale. Gulfport drilled the most prolific oil well in Ohio in 2013, with 41,617 barrels of oil from a single well over the course of 70 days. It also drilled the top gas well in Ohio in 2013, with 1.2 bcf of natural gas over 89 days. With over 147,000 acres of promising land in the Utica, Gulfport should continue to post impressive numbers.
Higher natural gas prices are not only good for drillers, but it could also breathe a bit of life into the coal mining sector as well. Coal has struggled over the years due to low natural gas prices, but with prices back up, utilities may switch back to coal. So, investors could play this angle as well, although it is much riskier. Cloud Peak Energy (NYSE: CLD) is a major coal producer, one of the largest in the nation, and the only pure-play on Wyoming’s Powder River Basin. As one of the lowest cost coal producers in the lowest cost coal producing region, Cloud Peak is positioned well to benefit from a brief resurgence in coal prices and demand. It operates several mines in Wyoming and ships coal to electric utilities in the Midwest, Southeast, Southwest, with a small quantity shipped to Asia. It is one of the few profitable coal producers left in the United States. Other major coal producers like Peabody Energy (NYSE: BTU) and Arch Coal (NYSE: ACI) may also get a lift in their share prices from an improved 2014, but they have been hammered in recent years and are very risky bets. Over the long-term, investors need to be wary of all coal producers, as environmental regulations will tighten in the coming years. But, for the short-term, there is some money to be made in coal.
Another way to bet on a rise in natural gas prices is railroads. That may seem a bit of a stretch, considering that natural gas isn’t really transported by rail. But railroads – already getting a big payday by shipping Bakken oil – may get a further lift from a boost in coal shipments, as mentioned above, which is a side effect of higher natural gas prices. Coal is by far the biggest cargo carried in U.S. rail. So, a player like CSX Corporation (NYSE: CSX), a major rail shipper that delivers coal cargos to electric utilities, is well situated to get a lift. It has a market cap of $27.42 billion and earnings per share of $1.83, along with a $0.60 per share dividend. Coal transport accounts for nearly one-quarter of CSX’s revenue, and while depending heavily on coal for your business will be a liability over the long haul, for 2014 CSX has some good prospects.
The spike in natural gas in February to over $6/MMBtu was likely an anomaly, owing to extremely cold weather and supply constraints. Yet, the years of sub-$2/MMBtu gas was also an anomaly, albeit a longer one. We have returned to an era of sane natural gas prices. This provides investors an opportunity to get in on a few companies before they profit from the rise. The obvious way to do that is to bet on a few key drillers, but coal and rail also offer an avenue for investors. This window will likely close as more people catch on, so make your picks now.