The Last Act Of A Generous Glut

Investor's Business Daily

In 2003, just after the second in a series of massive spikes in natural gas prices shut down portions of the U.S. power grid and rattled the economy, Federal Reserve Chairman Alan Greenspan explained that the country's ability to produce natural gas wasn't nearly sufficient to meet its needs.

At the time, he was right. But within five years, the shale-energy revolution had launched a production surge bestowing upon the U.S. a vast oversupply of natural gas.

Natgas prices plummeted 82% in the 12 months through September 2009. They dropped another 18% through April 2012.

"(Now) we are drowning in nat gas," said Fadel Gheit, managing director of oil and gas at Oppenheimer. "We are sitting on a 100-year supply of nat gas in this country.

In the past 12 months, prices rebounded 115% due to a combination of restrained production and rising demand. Futures suggest prices are headed higher, and demand appears to be strengthening. Analysts have different views on whether gas price gains will hold, or continue higher from here.

If prices hold, oil and gas companies are expected to shift production assets back to gas. As demand heats up, oilfield service providers led by Halliburton (HAL), Baker Hughes (BHI) and Schlumberger (SLB) — some of the company's hit hardest when gas producers cut back drilling and fracking operations in 2012 — are among those expected to benefit from the change.

New Era Of Natural Gas

The new, plentiful supply and promise of lower prices has coaxed a growing number of industries to shift to, or begin to incorporate natural gas into their energy budgets. Electrical generation plants, trucking fleets, on- and off-road truck and heavy equipment producers and railroads have all invested in significant steps toward adopting natural gas fuels.

The result: rising demand.

Additional demand from export markets is likely to add more price pressure. Earlier this month, the Department of Energy approved a liquefied natural gas facility in Freeport, Texas, to begin exporting up to 1.4 billion cubic feet of liquefied natural gas per day to Japan and Europe. One other facility was previously approved, Sabine Pass, in Cameron Parish, La.

"The era of natgas is just beginning," said Phil Flynn, a senior market analyst at the Price Future Group. "I expect a boom in demand.

Who Benefits If Prices Rise

The rise in prices is good news for pipeline operators which, as a group, are already up 24% so far this year. Future LNG exporters and railroad companies like Burlington Northern are also set to benefit, Flynn says.

While scant few energy companies are 100% oil or 100% natural gas, nearly pure play gas companies like Chesapeake Energy (CHK), Cabot Oil & Gas (COG) and Range Resources (RRC) are seen having an edge if prices continue higher. Flynn believes Chesapeake will also be a good takeover target as prices lure big oil further into the natural gas space.

A broad range of drilling operators and service providers would likely see the earliest benefits of a revival of natural gas production, as producers spend to expand operations.

"Producers will be the last to benefit, but will probably benefit the most in the end," Flynn said. Players like Halliburton and Baker Hughes reported double-digit earnings declines in the last three quarters as cheap gas prices shifted the industry's drilling focus from Appalachia to to shale oil fields spread from Texas to Canada. The move left rigs idle in the East, and saddled service companies with massive logistics challenges as they shifted operations westward.

But the restart of natgas production isn't expected to hit service providers as hard.

"They will benefit from more drilling," Gheit said. "The higher prices will attract more capital and when prices go up, drilling goes up.

Demand for oil has remained weak, but prices have been steady enough in the past year to encourage companies to keep drilling.

"With the current oil prices, they are making a lot of money so they can continue to spend a lot of money in drilling for oil," Gheit said. "The (service providers') technology isn't just sitting. Oil service companies can charge more for equipment and they can increase the number of rigs or boost rent rate of the rigs" as energy companies drill for both oil and gas.

Despite the some shifts in activity, the companies don't expect to see an immediate boost in profit.

"Recently we have seen an uptick in natural gas prices. However, our outlook for gas activity this year has not materially changed," said Halliburton CEO David Lesar during the Q1 conference call on April 22. "Our view is that natural gas drilling will not be a major activity driver in 2013 in the U.S.

Baker Hughes CEO Martin Craighead was more optimistic on his company's Q1 conference call April 19. Although he doesn't think the current price, just above $4.20 per million British thermal units, to be enough for energy companies to shift their focus back to dry gas basins, he expects "these higher prices should help support, if not stimulate, additional investment in oil-directed drilling.

Craighead believes the North American market is "on the road to recovery" and projects rig count rising.

The Downside

A rise in natgas prices isn't welcome news for everyone. Refiners, led by players like CVR Energy (CVI), Valero Energy (VLO) and others, have climbed as the cheap gas eased high energy costs associated with the refining process. But, analysts expect margins to narrow as natural gas prices rise.

More expensive gas also would mean squeezing margins for fertilizer makers and chemical producers, which use natural gas both as a raw material and as an energy source for production. The same is true for a host of other industries, from utilities to aluminum producers, which consume vast quantities of gas to power their operations.

Overseas, U.S. approval of LNG exports is likely to hit Russia and Iran, which have held sway over pricing in Europe and Japan. The Middle East and North Africa invested heavily in LNG export facilities in the years prior to the U.S. boom, expecting the U.S., China and India to be their top customers.

Like all commodity price increases, rising natural gas prices would hurt consumers by boosting inflation, according to Oppenheimer's Gheit. Even so, Price Future Group's Flynn believes rising natural gas production will continue to help the U.S. economy emerge stronger from the recession.

"We can't look at this boom and expect it to cure all our problems," he said. "We can't squander this opportunity to improve our economy in different ways.

What will be the ultimate effect of rising gas prices on the economy

"The jury is still out," Gheit said. "But I think it will be mildly negative. But remember we endured $11 or $12 per million cubic feet in April 2008, so gas has been on sale for the last five years."

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