Natural Gas Is Still a Steal

Last week we held the monthly joint web chat for subscribers of The Energy Strategist (TES) and MLP Profits. The chat is conducted by Igor Greenwald, managing editor for TES and chief investment strategist for MLP Profits, and myself.

There was a large spike in interest in the latest chat, and we received a larger than normal number of questions. We place a priority on answering questions about portfolio holdings and recommendations during the chat, but are often asked about other companies in the energy sector. Sometimes we may get questions that require an extended answer, or there may just be so many questions we can’t get to them all. Below I will address three remaining energy sector questions from the chat. (For answers to some remaining MLP questions from the chat, see this week’s MLP Investing Insider.)

Q: The prospect of LNG exports and the trend to convert to NG from coal for electrical generation should put upward pressure on the price of NG. In what time frame do you see this happening?

Some of that is happening now. The price of natural gas has risen to $4.27 per thousand Btu (MMBtu), which is $1 more than it was this time last year, and more than double the price at which it bottomed in 2012. But if you look at the New York Mercantile Exchange (NYMEX) futures, traders are betting that gas will stay below $5/MMBtu for nearly a decade. At last Friday’s close, you had to go all the way to January 2022 to find a contract trading above $5. And contracts expiring five years from now are actually trading at a slight discount to today’s price.

I would be shocked to see US natural gas below $5 in five years. When Cheniere Energy’s (NYSE: LNG)  Sabine Pass Liquefaction Project comes online in 2016 — with competing export terminals close behind pending the addition of two trains to Cheniere’s Sabine Pass facility — I think gas will be priced significantly higher than it is today.

In addition to the five LNG export applications already approved by the DOE — which would represent 6.8 billion cubic feet per day (bcf/d) of natural gas exports — another 23 are under review. Approving all would give the US a total export capacity of 35 bcf/d (equivalent to more than half of the 65.7 bcf/d of US natural gas production in 2012).

Obviously, all of these projects won’t be completed. But the Energy Information Administration (EIA) attempted to quantify the effect of increased exports in a 2012 report. Under the scenarios it modeled, 12 billion cubic feet per day of natural gas exports would increase domestic natural gas prices by $1.58/thousand cubic feet (Mcf; there is roughly 1 MMBtu/Mcf) on the low end to $3.23/Mcf on the high end (36 to 54 percent from their baseline).

Bottom line, I see natural gas prices making a decent move upward over the next three to five years. Traders will begin to bid up contracts as the LNG export facilities move closer to beginning operations. The proposed EPA regulations that would effectively preclude new coal-fired power plants are just icing on the cake.

Q: Statoil has been active in making acquisitions and establishing international partnerships.  Do you think it is in the class of Total and Eni?

Over the past 12 months, domestic integrated oil companies like Chevron (NYSE: CVX) and ExxonMobil (NYSE: XOM) are up 13 percent and 8 percent respectively, while Statoil (NYSE: STO) is down by 8 percent over the same period. Results were mixed for Statoil’s European peers, with Total (NYSE: TOT) up 11 percent and Eni (NYSE: E) down 6 percent.

But Statoil’s operations are indeed in the class of Total and Eni, and they compare favorably in most categories with these and other European integrated oil companies. Statoil is without question a world class integrated oil company. And if you do stock screens based on the Price to Earnings (P/E) Ratio or Enterprise Value/EBITDA, Statoil perpetually looks cheap relative to most peers. But there are some reasons for this.

Some Statoil performance indicators relative to competitors. Source: Statoil investor presentation.

The biggest thing working against Statoil is that two-thirds of the shares are owned by the Norwegian government. This differs from Eni (~30 percent government-owned) and Total (less than 10 percent government-owned). Statoil’s ownership situation is similar to that of Petrobras (NYSE: PBR). And Petrobras shareholders have learned the hard way what can happen when the government is forced to choose between voters who are unhappy with high fuel prices and the interests of the company. Petrobras was forced to sell fuel at a loss, which was great for Brazil’s citizens but not so good for Petrobras shareholders.

The other issue with Statoil is that the company pays taxes at a far higher rate than most competitors. When the company’s taxes are taken into account and the stocks are screened against net income, Statoil suddenly no longer looks so cheap. So Statoil’s discount to peers is really deceptive. You are probably better off buying a US-based competitor, but if you really want a European-based integrated oil company, you would probably be better off with Total.  

Q: Why did Atlantic Power come down so much? Is it a bargain now?  

We are frequently asked about Atlantic Power (TSX: ATP, NYSE: AT) during the monthly web chats, and our response is generally that we don’t cover the company in The Energy Strategist or in MLP Profits. As a Canadian independent power producer, Atlantic Power is covered by our sister publications Canadian Edge and Utility Forecaster.

Atlantic Power was a long-time favorite in the past, but the company’s fortunes soured over the past year. In February management cut its 2013 project-adjusted EBITDA guidance and the company’s dividend. The share price had already begun to fall, but it plummeted by more than 50 percent when the dividend was slashed by nearly two-thirds. Many who invested in Atlantic Power believing the dividend was secure were painfully reminded that sometimes dividends come with unacceptably high underlying risks.

The company did report solid third-quarter results, but during the conference call management left open the possibility of another dividend cut announcement in early 2014. The stock is now down 70 percent year-to-date, and is presently trading at a 34 percent discount to the $5.23 book value of the company. This will give some comfort to investors searching for a bargain, but I would guess many also felt this book value offered some protection as the share price declined to book value.

As an income investor, I wouldn’t go near this company. The future is still far too uncertain, and management has made decisions that seriously harmed dividend investors without providing adequate guidance that would have warned of impending problems. Very aggressive investors could profit from a short-term rebound at some point, but there have been false starts in the recent past. Shares rallied 25 percent in October, before proceeding to fall 40 percent. Buyer beware.

Next week I will address the remaining three or four energy sector questions.

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