Long-term natural gas prices are strong and likely to stay that way for several years, which in turn could boost the shares of many gas-focused exploration and production (E&P) stocks 30-50% higher from current levels, according to a Raymond James analyst.

Jeffrey L. Mobley said in the latest “Stat of the Week” that typically, E&P assets in the private market trade at the 10-20% discount to public market valuations. However, over the last year, the market has valued the proved reserves of publicly traded large-cap E&Ps (with 10-year reserve lives on average) between $1.20-$1.35/Mcfe, “whereas private market assets have traded in excess of $1.50/Mcfe for similar reserve life assets. We believe the public market is way off the mark,” said Mobley.

An analysis by Raymond James implies that the current $1.25/Mcfe market valuation of publicly traded E&Ps assumes a long-term gas price of about $3.25/Mcf and pre-tax discount rates of 12-15%. “We believe this valuation is unrealistic in the current natural gas price and interest rate environment,” said Mobley. “Using a conservative base, long-term natural gas price assumption of $4/Mcf, a more reasonable valuation range for E&P stocks is $1.50-$1.75/Mcfe, depending on the level of risk and growth opportunities in a company.”

Mobley said a “good case” can be made for long-term gas prices around $5/Mcf or more, based on potential delivered prices of future liquefied natural gas imports to the United States. In the $5-plus scenario, he said E&P stocks could be valued in excess of $2/Mcfe.

The major assumptions for the Raymond James’ model assumed a typical operating cost structure for an E&P of $1/Mcfe plus 7% for production taxes; a proved reserve mix of 70% natural gas and 30% undeveloped reserves; and an additional 10% of the value of proved reserves to account for unproved reserves and going concern value, among other things.

“In our view,” said Mobley, “investors have remained wary of a 2001 repeat performance. The price spike of two years ago was a demand-driven event that was quickly corrected by higher prices. However, we remain convinced that the current higher natural gas environment is a long-term, supply-driven event that will persist for the next four or more years until additional supply becomes available from meaningful imports of LNG. Even at that time, we believe that natural gas prices must average at least $4/Mcf (potentially more than $5/Mcf) in order for the U.S. to attract LNG spot shipments and long-term contracts in a very competitive world market.”

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