Natural gas likely to play a bigger role
Pure plays such as Encana well-positioned as U.S. shifts toward greater consumption of abundant resource
Larry MacDonald
Thursday, Jun. 17, 2010 7:00AM EDT
What do high-profile investors Jim Cramer, George Soros and T. Boone Pickens have in common? They are all bullish on natural gas playing a larger role in meeting energy needs over the coming years. Solar and wind power may eventually emerge as the face of renewable energy but natural gas can be the bridge until these alternative energy sources are fully viable.
Why natural gas now? The old chestnut is that it is cleaner than the other fossil fuels. It generates 30 per cent less carbon dioxide than oil and 40 per cent less than coal, says Mr. Cramer. And, of course, it can be brought on stream quickly compared to wind, solar, and even nuclear, power.
The new chestnut is that innovations in extraction technologies, notably hydraulic fracturing and horizontal drilling, have made many more deposits of natural gas accessible. Along with ongoing expansion in the transportation infrastructure for liquefied natural gas, this has resulted in a much more abundant and cheaper fuel source.
Indeed, estimates of U.S. gas reserves have skyrocketed because of the new drilling methods. Energy experts on the Potential Gas Committee declared in June, 2009, that recoverable U.S. gas reserves stood at 2,000 trillion cubic feet in 2008, a record jump of 34 per cent. “That’s enough natural gas to power [the U.S.] through the 21st century,” said Mr. Pickens – formerly an advocate of wind power.
A more recent report (in February) by J.P. Morgan Securities Inc. concludes North America has 8,000 trillion cubic feet, four times more than the committee’s calculation. If the committee’s estimate meant U.S. needs were met for a century, then J.P Morgan’s estimate implies U.S. needs are covered for several centuries.
With natural gas so plentiful and inexpensive, Mr. Cramer and Mr. Pickens also see it as the solution to the age-old problem of weaning the U.S. off its dependence on foreign oil. Moreover, say the two, if the U.S. were to ramp up drilling, building of pipelines and conversion of power plants and vehicles to natural gas, it would be a major generator of the jobs so desperately needed at this time.
Obama’s ‘game-changing’ speech
In early June, natural gas prices and stocks got a lift off their depressed levels when U.S. President Barack Obama made a Pittsburgh speech in which he declared: “the time has come … to fully embrace a clean energy future …. [it] means tapping into our natural gas reserves ….” The market took such comments as evidence of the President’s intention to work toward the passage of legislation favourable to natural gas.
One such bill now on Capital Hill is the Natural Gas Act, which contains a number of credits and subsidies to encourage the use of natural gas. Specifically, it seeks to promote the conversion of vehicles to natural gas, expansion in the number of refilling stations and development of natural gas technologies.
Mr. Soros has some bets on vehicles using more natural gas. The Soros Management Fund reported recently that it has a stake of nearly 5 per cent in Vancouver-based Westport (19.77-0.21-1.05%) which has patented technology to convert diesel truck engines to natural gas (and is working on developing natural gas engines for trucks).
Mr. Obama’s “game-changing” speech (as Mr. Cramer called it) also conveyed a commitment to rounding up enough votes to enact the American Clean Energy and Security Act with its “cap-and-trade” provisions. It won’t be easy, but if the President succeeds, then “putting a price on carbon pollution” could generate a noteworthy incentive for energy users to shift to natural gas.
Investment opportunities
A May, 2010, report prepared by National Bank Financial analysts Angelo Katsoras and Pierre Fournier, “Investing in the Natural Gas Revolution,” outlines investment opportunities expected to arise from the shift toward greater consumption of natural gas. They include:
•large, deep-pocketed oil companies replenishing their reserves with natural gas, notably Shell (54.500.450.83%) (66-per-cent gas) and Exxon Mobil (62.51----%) (49-per-cent gas)
•independents with large reserves of unconventional gas, two pure plays being Oklahoma City-based Chesapeake (25.18-0.18-0.71%) and Calgary-based Encana (35.12-0.31-0.87%)
•equipment and service providers focused on locating and extracting unconventional gas, such as Houston-based Schlumberger (60.81-0.06-0.10%) and Baker-Hughes Inc. (43.980.390.89%)
Encana
Of the various investment opportunities, perhaps Encana deserves special attention.
After hiving off its oil assets into a separate company in 2009, it is now focused on unconventional natural gas – with exposure to the shale gas fields of Horn River and Montney in British Columbia, Haynesville in Louisiana, and Barnett in Texas. Its reserves are pegged at nearly 20 trillion cubic feet, among the highest of the North American independents with shale gas assets.
This makes Encana “another potentially juicy morsel for a greedy major,” writes Derek Brower in the February issue of the Petroleum Economist magazine. Following Exxon Mobil’s $41-billion (U.S.) acquisition of shale gas player XTO Energy Inc. in December, Mr. Brower sees a wave of consolidation hitting the continent’s shale gas sector, with Encana being one of prize catches thanks to its status as one of the few large, pure plays.
Encana’s chief executive officer, Randy Eresman, sees it differently. The splitting off of the oil assets has boosted the market valuation of Encana’s gas assets, making it much more expensive for an acquirer to submit a bid.
What Mr. Eresman sees ahead for Encana is a lot of growth. First, there is the prospect of jumps in demand resulting from governments introducing programs promoting natural gas (as mentioned above). Second, with new drilling technologies lowering costs and enlarging reserves, there is the potential for increased North American exports of natural gas.
Third, with the current market price (5.050.081.55%) for natural gas so low, Mr. Eresman anticipates some rivals will be forced out of the industry, leaving behind customers for the lower cost producers. Encana is not only one of the lower-cost firms but is pursuing a strategy of becoming the lowest cost producer (Mr. Eresman rose to the CEO position thanks, in part, to his skill in deploying capital and technology to extend the life of wells).
Fourth, Encana intends not only to maintain the 10-per-cent annual growth rate in its unconventional natural gas operations but to increase sales by another 4 to 5 per cent per year. Some analysts have misgivings about this gambit when supply is already ample and prices are low.
But Mr. Eresman hopes to fill some of the void left behind by departing producers. Moreover, Encana has hedged much of its future production above the spot price. About 60 per cent is hedged at $6 (U.S.) per thousand cubic feet (mcf) in 2010. In 2011, a good portion is hedged at $6.50 mcf.
In short, even if favourable policy changes fail to appear and prices remain low, Encana may be able to deliver by growing sales and earnings through volume increases. Should higher natural gas prices occur, they would be gravy on top of the volume strategy. Lastly, in addition to the potential for capital gains, there is the dividend paying close to 2.5 per cent.
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