Natural gas prices have been rallying a bit lately, and stocks “tend to correlate” with changes in the forward curve, but the stock price rally hasn’t been accompanied by a gain in the strip price, Tudor, Pickering, Holt & Co. (TPH) analysts said in a note to clients.
The 2014 curve is up more than 4% year-to-date, and it stood at around $4.20/Mcf on Monday. However, there’s not much new activity expected in the gas patch.
“Our view remains the same: modest production declines support a $3.00/Mcf-plus price,” but a $4.00 price is needed for “modest supply growth” and “too much above $4.00 is met with greater supply response than needed.”
As such, gas prices likely will be “rangebound from $3 to low $4’s nearer term and mid $4’s medium term,” TPH said. The equity rally “has far exceeded our expectation,” with stocks up more than 18%, but the “move looks overdone, and we would be booking profits, especially on stocks with more marginal assets/balance sheets.”
The “beta rally” is going full steam and some of the levered, gassy exploration and production companies “have seen staggering moves over the last two weeks,” said analysts. Among the top gainers are Quicksilver Resources Inc. (58%), Ultra Petroleum Corp. (24%) and Exco Resources (18%).
However, the “group isn’t cheap” with many names now trading above the net asset values of their proved, probable and possible (3P) reserves, based on $5.00/Mcf long-term gas prices. “Near-term gas fundamentals likely have a ceiling around $4.00/Mcf, limiting additional momentum.”
Could 2013 be taking a page from 2012? Last year, said the TPH analysts, spot natural gas as prices reached a low of $2.00/Mcf in April before rallying to $4.00 in November. “Equities traded with some lag to spot but eventually skyrocketed in a similar fashion.”
Meanwhile, equities on average “moved up 45% over the following four months before plummeting in 4Q2012 as gas peaked and then declined.”
It won’t take much to “tip the finely balanced scale,” said analysts. “Management teams have continued to lower the price at which they show willingness to add back incremental gas rigs,” which in general begins at a price of “around $3.75 and accelerates in earnest above $4.00/Mcf.”
The lower threshold, said TPH, “has been driven by high-graded drilling, improved well results and lower service cost with most rigs targeting acceptable returns between $3.00-3.50/Mcf. “Expect hedging to increase and activity to pick up in the second half of 2013 on today’s strip.”
BMO Capital’s Dan McSpirit and Phillip Jungwirth said in a note that they like gas fundamentals more than oil “at this point” and continue to recommend that investors turn to gas-weighted operators over oil-weighted producers. The BMO analysts said gas prices have risen about 6.7% to $3.87/Mcf in synch with the Dow Jones rally.
“The increase in gas prices has led to renewed investor enthusiasm for natural gas producers with the more heavily shorted names gaining the most ground,” wrote McSpirit and Jungwirth. “The effect also spread to the energy services group, which was led by sharp gains in the pressure pumpers.”
TPH’s analysts said the U.S. oil and rig count for the week ending March 15 proved to be another frustrating data point, with conflicting numbers from RigData (minus 19 rigs week/week); Baker Hughes (19 rigs added, including 24 gas rigs, and a loss of two oil rigs); and Smith Bits, which reported the loss of one rig week/week and down 21 rigs over the past four weeks.
The “choppiness of third-party data” isn’t helping to determine where the domestic rig count is headed, as “underlying activity” is “masked by rig mobilizations, transitory weather impacts, etc. We believe 1Q2013 activity is playing out as land drillers themselves generally telegraphed on Q42012 earnings calls, with the U.S. land rig count having troughed early/mid-January, bounced a touch in late-January/early-February but flattish ever since.”
Based on their review, analysts expect the 1Q2013 rig count will fall 3-4% in 1Q2013 from the final three months of 2012, “given that there are only two weeks left in the month.” The count could go higher because the bias is “directionally higher versus the current level given continued healthy crude oil prices and the natural gas-oriented rig count having finally bottomed…”
The “key issue” remains one of timing and the magnitude of the U.S. rig count recovery.
TPH analysts said they’ve not seen nor heard evidence that warrants changing their view that the domestic rig count may start to trend higher in April through June. Analysts are modeling a gain of 40 rigs, or a 2% rise quarter/quarter from 1Q2013. However, for the year, they still expect a 60-rig decline from 2012, or down about 3% year/year.
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