Two Nat Gas Plays for the Future

• ByJonathan Moreland, InsiderInsights Research Director
• On 2:00 pm EST, Wednesday November 19, 2008

Value, value everywhere, but no support in sight. That's been the lament of every bottom-fisher for months now, but I think the value argument is actually worth considering when it comes to natural gas plays.

Don't get me wrong. I fully realize that the whole concept of value is still in the process of being defined down as investors realize this recession is for real. But to heck with value based on price-to-sales, earnings, or even earnings before interest, taxes, depreciation and amortization (EBITDA).

In Chesapeake's third-quarter conference call, Chairman Aubrey McClendon pointed out that (based on partial sales of Chesapeake's holdings) his firm's remaining stake in Louisiana's Haynesville Shale region alone is now worth more than Chesapeake's entire market capitalization. The Arkansas Fayetteville Shale stakes are worth half again as much.

The value at SandRidge Energy appears just as compelling. At present enterprise value, you can theoretically buy the firm's proven reserves of natural gas at less than the firm's all-in costs of aggregating that asset. These are the sort of value stats that can actually keep my interest these days.

Third-quarter financials for both Chesapeake and SandRidge were perfectly decent as well. But it hardly seems relevant to mention that SandRidge's cash flow from operations increased 87% year-over-year, to $137 million, or that Chesapeake's smart hedging allowed it to increase adjusted earnings per share by 47%, to 85 cents. Nobody expects this sort of financial growth next year, as rig counts are destined to decline with economic prospects in 2009.

Another negative is that natural gas prices (and related property sales prices) could fall much more if it becomes apparent that the severe recession the U.S. seems destined for turns out to be the Great Depression II.

But shares of both Chesapeake and SandRidge Energy are already off more than 2 and 3 times, respectively, the natural gas price of $8 per 1,000 cubic feet equivalent (Mcfe) at which I entered these two losers. A good part of the bearish scenario appears priced in, while none of the bullish natural gas scenarios are.

Even as oil prices fell below $60 for most of November, natural gas prices were actually up somewhat from a bottom of about $6.20 per Mcfe hit last month. Prices even crossed above $7 per Mcfe again earlier this month and have held up well even in the face of recent stats showing larger-than-expected natural gas inventory.

That divergence gives some cautious optimism that the seasonal influence on natural gas prices is again ready to push them higher -- or at least support them right here. Either way, the value argument for SandRidge and Chesapeake is intact.

Of course, the real bullish scenario would be for natural gas to be included in a coherent national energy policy geared toward making energy independence an actual policy instead of the political slogan it has been for decades. While Chesapeake's McClendon can be accused of talking his book when he speaks out in favor of T. Boone Pickens' initiative to use natural gas as vehicle fuel, I think it makes a lot of sense to at least investigate further.

GM and Ford already make cars that can use natural gas for the Brazilian market, and we already have natural gas and gas liquids flowing through the midstream distribution system across the country.

While there are many more obstacles to overcome before filling up with compressed natural gas (CNG) could be commonplace, a conversation I had with an operator of CNG cabs in Las Vegas was telling. He mentioned several times that added costs for tests mandated by the U.S. Environmental Protection Agency kept his operating costs higher than he originally expected. Yet even after the extra regulations, he found it cost-effective to convert cars to CNG for the business.

Is real action toward energy independence a low-odds possibility even now? Sure. But it's one with huge potential payoff for any natural gas stock. What is not low odds, however, is that fossil fuel prices will spike again after the economy hits bottom. Nobody knows if that is two months from now, or two years. But when it happens, investors will wish they had bought into natural gas stocks around now.

I have not advocated jumping wholesale into insider-bought value plays yet, but I am definitely staking a claim to value in the natural gas sector. It seems as legitimate a sector as any to start getting some money to work, even though it will be a volatile ride until the real payoff occurs.

This article was written by Jonathan Moreland, whose newsletter, "TheStreet.com InsiderInsights," parses mounds of data on insider trades to find investable ideas.

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Know what you own: Moreland mentions natural gas. Other companies in the oil and gas drilling industry include Petrobras , Transocean and Diamond Offshore .

Buzz up!