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Alex Kimani

Alex Kimani

Alex Kimani is a veteran finance writer, investor, engineer and researcher for Safehaven.com. 

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Two Ways To Play The 107% Rally In Natural Gas

The oil sector has lately been hogging the limelight after a spectacular recovery that has set the sector as one of the top performers in the current year. However, it's natural gas bulls who have been having a real ball with natural gas trading at its highest levels since 2014, outpacing oil and many other commodities.

On Friday, natural gas futures were trading up 0.6%, to $5.03 per million British thermal units (BTUs), their highest settlement price since February 2014. Natural gas prices are up 107.9% in the year-to-date, while the biggest nat. gas benchmark, the United States Natural Gas ETF, LP (NYSEARCA:UNG) is up 90.1% over the timeframe.

Natural gas bulls have rising gas demand and a supply crunch to thank for the impressive gains.

An unusually cold winter in Europe as well as a global rebound from Covid-19 have triggered strong demand and depleted natural gas inventories. Meanwhile, Hurricane Ida has knocked out a considerable amount of gas production, with 77% of oil and gas production still offline in the Gulf of Mexico. According to U.S. government statistics, natural gas inventories are currently 17% lower compared to a year ago and 7% below the five-year average.

Here are 2 more ways to play the natural gas boom.

Natural Gas (Henry Hub) USD/MMBtu

Source: Business Insider

#1. Buy Chesapeake

Commodity price hedging is a popular trading strategy frequently used by oil and gas producers as well as heavy consumers of energy commodities such as airlines to protect themselves against market fluctuations. During times of falling crude prices, oil and gas producers normally use a short hedge to lock in oil prices if they believe prices are likely to go even lower in the future. According to Tudor Pickering Holt & Co via Barron's, the majority of the energy companies they cover have hedged away significant portions of fourth-quarter cash flow (about 85% hedged on average in the US).

Unfortunately, hedging also means that these companies are unable to enjoy the benefits of rising gas prices and can, in fact, lead to hedging losses.

However, some bold producers betting on a commodity rally hedge only minimally or not at all.

Tudor Pickering rates Chesapeake Energy (NYSE:CHK) a Buy, saying the company remains one of the few producers that remain relatively unhedged.

This might come off as an odd pick given Chesapeake's history but somehow makes sense at this point.

Widely regarded as a fracking pioneer and the king of unconventional drilling, Chesapeake Energy has been in dire straits after taking on too much debt and expanding too aggressively. For years, Chesapeake borrowed heavily to finance an aggressive expansion of its shale projects. The company only managed to survive through rounds of asset sales (which management is averse to), debt restructuring and M&A but could not prevent the inevitable--Chesapeake filed for Chapter 11  in January 2020, becoming the largest U.S. oil and gas producer to seek bankruptcy protection in recent years.

Thankfully, Chesapeake successfully emerged from bankruptcy this year with the ongoing commodity rally offering the company a major lifeline.

The new Chesapeake Energy has a strong balance sheet with low leverage and a much more disciplined CAPEX strategy. 

The company is targeting <1x long-term leverage in a bid to preserve balance sheet strength, target production is 400+ thousand barrels / day and intends to limit CAPEX to $700-750 million of annual capital expenditures and positive FCF. CHK says it expects to generate >$2 billion of FCF over the next 5 years, enough to improve its financial position significantly. 

CHK shares are up 35% since its March comeback, significantly better than the 26% YTD gain by the Energy Select Sector SPDR Fund (NYSEARCA:XLE).

#2. Buy Cimarex Energy

Meanwhile, Mizuho has picked Cimarex Energy (NYSE:XEC) as another stock to play the natural gas boom.

Mizuho has upgraded XEC to buy from Neutral with a $95 price target, citing the company's "now-attractive free cash yield" following recent weakness and payout capacity of its merger with Cabot Oil & Gas (NYSE:COG).

Mizuho says the combined entity trades at an attractive value compared to oil peers and at "just a small premium" vs. gas peers following weakness since the merger announcement.

"Balance sheets have improved significantly YTD, positioning the group for attractive cash return not only at $65/bbl but through the cycle, and we remain very constructive for that reason, with average upside 46% in our oil coverage," Mizuho's Vincent Lovaglio writes.

Natural gas already makes up the majority of Cimarex's production which should climb even further after its merger with Cabot, another primary nat. gas producer.

Can the gas rally continue?

The million-dollar question right now is whether this rally still has legs to run after this year's spectacular gains.

We think the rally might not have much steam left in the short-term. According to the latest data by the Energy Information Administration, natural gas inventories last week climbed +52 bcf vs. +40 bcf consensus, and +20 bcf last week, suggesting that the supply crunch is easing or demand is falling. The futures markets also appear bearish,  with front-month gas futures trading above $5 while futures expiring a year from now are at $3.70, suggesting that traders believe the current high price levels will not last.

Nevertheless, the long-term nat. gas outlook remains bright thanks to strong LNG growth and natural gas' new role as an energy bridge during the shift to renewable energy.

By Alex Kimani for Oilprice.com

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Leave a comment
  • George Doolittle on September 12 2021 said:
    "sell" obviously.

    None of this is based on a single economic fundamental in the US economy which has been plunged into a massive recession once accounting for inflation.

    Long US Treasuries
    Strong buy

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