3 Indicators Pointing to a Rally in Natural Gas

Economic Conditions Appear Favorable...For Now

Don’t look now, but things are beginning to look up for the oil and gas industry.  The timing couldn’t be better, as Shreveport-Bossier (SB) is badly in need of a spark to stimulate the seemingly stagnant economy.  Unfortunately, it is not likely a coincidence that SB’s recent economic slump occurred during an almost identical period in which national oil and gas markets were pummeled.  To the contrary, Shreveport-Bossier’s economy has thrived and suffered in lockstep with broader energy markets.  For better or worst, this is the economic position we find ourselves in, so I would like to direct your attention to indicators that point to an upswing in the oil and gas industry.

For starters, the shake-up in Washington, D.C. is beneficial for domestic producers of fossil fuels, as our new President is expected to discontinue government subsidies for renewable energy and allow free enterprise to dictate energy price and policy.  In my opinion, this sets the tone for a resurgence of the U.S. oil and gas industry (particularly natural gas), as I believe new leadership can set a course for energy independence and the maximization of our abundant resources.

Locally, I fear the publicly-traded exploration and production company’s have caused irreparable damage.  The blitzkrieg of leasing, lease-bonus payments, overriding royalties, and drilling that followed the Haynesville shale discovery has forever altered the Shreveport-Bossier market.  Everyday people are now cognizant of the mineral interests they own, so surface acreage is rarely sold with minerals included.  Excasberating this problem, landowners owning a sizeable chunk of property now expect a one-eighth royalty and a $5,000/acre lease bonus in exchange for their lease.

Despite these unfavorable conditions, the recent period of depressed prices is forcing many of these companies down one (or both) of the following paths:

  • Forming asset divestiture programs for the purpose of selling groups of assets or segmented chunks of assets to the highest bidder.  For example, Chesapeake Energy Corp. recently agreed to sell a combined 119,500 net acres (or 54.8%) of its Haynesville shale position to Indigo Minerals, L.L.C. (Indigo) and Covey Park Energy, L.L.C. (Covey).  The asset divestitures were announced in December 2016, and the combined sales price totals $915 million.  Not surprisingly, however, the company elected not to disclose its basis in the properties, so this leads one to believe the losses realized from these sales must be extraordinary, and/or
  • Filing bankruptcy in order to reorganize debt or in complete liquidation (Samson Resources, Linn Energy, & Shoreline Energy to name a few)

The flip side to asset divestitures and bankruptcy generally involve a competitor acquiring the distressed company’s asset(s) at a steep discount.  In the aforementioned Chesapeake Energy example, Indigo and Covey are effectively purchasing large sections of mineral leases, existing wells currently in production, and estimated reserves yet to be recovered from drilling operations.  These acquisitions are expected to restore some equilibrium to our market, as they are expected to result in significant injections of new capital into the local economy, new jobs offering competitive compensation, and the trade-out of an irresponsible corporate citizen that damaged our economy for a responsible corporate citizen interested in establishing a mutually beneficial relationship over the long-term.

The Oracle of Omaha, Warren Buffet, once said “Only when the tide goes out do you discover who’s been swimming naked“.  This is the perfect analogy to describe several Fortune 500 companies that utilized credit facilities to finance huge positions in the Haynesville Shale.  In addition to over-extending themselves through the use of debt, they effectively purchased reserves at a premium by acquiring leases at peek prices.

In his article, Haynesville Shale Making a Comeback, John Kalmbach provides a through analysis of the economic outlook for Haynesville gas – concluding with optimism about the potential of shale gas moving toward a new price equilibrium.  Adding to his point on ascending price pressure, I note the Federal Reserve’s recent interest rate increase coupled with forward guidance that suggest additional hike(s) in 2017.  These actions are consistent with monetary policy aiming to combat inflation, and prices of a commodity such as natural gas generally increase during inflationary periods.

 Summary – 3 Indicators Pointing to Natural Gas Rally

  1. Federal policy set/influenced by new President sets a tone conducive to American producers of fossil fuels.  Specifically, President Trump will discontinue government subsidies for renewable energy, opting instead to allow free enterprise to dictate.
  2. Recent period of depressed prices has forced out weaker and detrimental participants, creating opportunities for higher quality E&P company’s to restore some equilibrium to struggling market.
  3. Supply and demand are evolving to the point where a new equilibrium (higher) price may be achieved.  The Fed’s monetary policy suggest concerns over inflation, and it has reacted with an interest rate increase and forward guidance about additional rate hikes.  Upward price pressure on commodities (natural gas) generally result during periods of rising inflation.

 

 

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