Lots of great responses on this board to my thread. Here's my thought process...right or wrong...about the future of NG prices.
1. NG is definitely the global fuel of the future and agree with everyone here about this. This means than NG demand will be increasing for YEARS to come. So we buy NG producers like RRC, right?
2. Wrong IMHO...NG is the fuel of the future because it is ubiquitous. It's plentiful in the US and globally in massive quatities. Any commodity where the supply is basically unlimited (over the next few decades, lets say) will gravitate towards its cost of production. The world has gone from wood...to coal..to oil...and now to NG. global CL production rates of likely peaked and now the move to NG...cause it is so available and so much cheaper. Has anyone looked at a monthly coninuous futures chart of Henrey Hub NG in a while? Look and compare it to oil. NG is in a very long bear move as it gravitates to the cost of production. Eventually it will go below cash flow break even on the next cyclical downturn in the US economy and they will stop drilling for NG and prices will bottom. The bad news for NG is drilling costs won't fall much more in the near term because the rigs are in such demand for crude oil.
3. This leaves us with RRC. The good news is its one of the lowest cost producers. Their balance sheet is pretty good when compared to other red chips in the sector. They will be ok if prices descend. The bad news is that the product they are selling is likely to remain below 5ish for a long time with brief spurts (lasting months) above and bust spurts well below. The reason being when NG becomes profitable to produce production will come on line quickly. My argument against RRC is it is simply overvalued. Their assets are priced higher the prime north american Crude acreage (BEXP). Their earnings aren't going anywhere quick...and could fall as hedging ops fall away over the coming 18 months. I don't see someone paying 70 or higher for NG assets with the current message of the strip pricing.
Overall, I could easily be wrong on RRC. Do your own DD. Hopefully, my post will get investors here to see the risk/reward situation for RRC and I think it isn't good...or at least see the other side of their long position. I wouldn't be surprised to see RRC hold up around 60 to 75 until the next US cyclical recession...and then it's going lower. Either way valuation will default toward earnings and cash flow multiples and not NAV based on a NG price assumption that's much too high.
Best to all...
Another way to think about the asset value of RRC is to estimate what a company would have to pay just for the approximate 800,000 Marcellus acres that are essentially de-risked if they were starting out today. If one were to discount the return on investment on an acreage basis, I bet the acreage is worth north of 40K per acre-multiply that x 800K subtract out the debt and you get one giant share price. Of course anlysts don't view the company that way, but as the Marcellus value is extracted the NAV of RRC increases in a huge way. Nat gas prices are low, so if you invest in RRC you have to believe that demand for the commodity and with RRC , also the liquids, will increase. I believe we will see a huge increase in demand, not only with power plants but also with transportation and with chemical plants using the ethanes. Kinder Morgan would not have bought El Paso if they saw it differently. It will happen with or without any incentives from an administration that remains clueless. When the chemical giants start building those cracker plants and the 18 wheelers convert to NG, we will see a shift in the commodity price. It's really a no brainer, its cleaner, will create millions of private sector jobs, doesnt damage the enviornment or radiate people and its domestic-just a matter of time. Bottom line is if you don't see a real future for nat gas you should be investing elsewhere.
Good points. Another value-added component (an extension to my intrinsic value theme) and this was mention several times at the conference call, is the midstream and major transmission pipeline build out and expansion projects. You can have high-priced gas but if you have an inefficient midstream and transmission pipeline system, your really at your end; all dressed up but no where to go! When in the field, it makes you think when you see the remnants of the old McDonald oil field gathering pipelines, typically 2 to 4 inches in diameter, toothpicks compared to the gathering systems today. The current midstream build out has come along way in past 2-3 years, and much more is on the way. Great thing it is all new. The Marcellus killed the KMP multi-billon dollar Rockies Express Pipeline project which dead ends in eastern Ohio, suppose to go all the way across southern PA to NY/NJ The reason is Spectra was quick to upgrade its transmission pipeline system to include loops for storage. NI, Nat Fuel Gas, and Equitrans did and doing the same. EPD has an open season for a new ethane line from Liberty to PADD-3. This will be a very expensive project though the right-of-way is in place via TEPPCO. It’s also going to cost more to downstream end users. And I believe environment impact studies etc. will definitely slow the project. But indeed the take-away ethane value is a very much real and is a must for all E&P outfits involved. MWE and RRC have planed Mariner East and West projects in place with SXL. Ethane IMO has created a PADD-3 versus PADD-1 chemical industry battle; and PADD-1, I believe will get its ethane crackers as well as new ethylene and related plants, again all this is going to be brand new facilities. In addition, a rail NGL take-away project is underway. Impact is end users of purity NGLs now have a new source from PADD-1 in lieu of PADD-3 via rail. Note the railway connects via WLE to all Class I’s including CNI to Canada. So for the first time, PADD-3 has real competition as PADD-1 picks up. Lower commodity prices, I don’t think too bad for efficiently operated outfits having brand new infrastructure; definitely great for a weak economy. One other value point, the infrastructure is out of hurricane alley. Oh also, some RRC’s Marcellus wells do produce crude oil. Now I guesstimated that for about a little over 200 wells, together averaged at or about 190 barrels per day. Now remember RRC has only drilled about 4% of the acreage, and this only includes the Marcellus formation. We’re now beginning to tap into the shallower Upper Devonian, and I suspect that is where potentially more oil can be had. So it will be important to keep an eye on the production and type of production on the Upper Devonian wells. My gut is we may get more oil in addition to the other goodies plus at lower cost. How much? Don’t know, but there are still oil wells producing in the area since the early 1900’s and beginning to see rework on some the mid-late 1970’drilled oil wells that have been non-producing since the late 70’s and mid 80’s. IMO for RRC and others, the Upper Devonian performance is critical.
Your argument is basically correct long term at equilibrium. There is lots of gas and it price should drop to the marginal cost of the highest cost producer. However that is not how it works in the short run and mid term across global markets. Is the price of oil always at the marginal cost of production? When you are the low cost gas producer you can make a fortune as the price fluctuates. Do you really think Exxon bought XTO without understand the the economics?
Wow, two impressive posts! I can't argue with either one, except to say that in the short term I think there is a lot of money to be made in RRC. The market may be a weighing machine in the long run, but it is a voting machine in the short run, as RRC has proved in the last year.