This winter is going to be a doozy. We could see a repeat of 2009-2010, which brought a big chill and “Snowmageddon.”
Fortunately for investors hunting for an angle, natural gas (NG) inventories just happen to be at their lowest level in years. The upshot: Prolonged cold and snow could lead to NG shortages and price spikes, which put a bid under much-hated natural gas stocks.
The five names I suggest below are trading near their 52-week lows. That makes them interesting contrarian plays. I’ve suggested several of them in my stock newsletter, Brush Up on Stocks, in part because insiders are buying them. Insiders challenging the market by purchasing hated names is often a great buy signal, and it’s a go-to tactic in my letter.
With the market looking shaky, NG names could outperform both the S&P 500 Index (.SPX) and the SPDR S&P Oil & Gas Exploration & Production exchange traded fund XOP (XOP) through the end of the year.
Before we get to the names, let’s look at the forecast. “It will be one heck of a winter,” says Joe Bastardi of WeatherBELL Analytics. “Major cold and a stormy winter are in the cards.”
How cold? The Midwest, Atlantic coast and Deep South could see temperatures one to five degrees below normal. That may not sound like much, but it is enough to make people feel a chill and turn up the heat. And there will be dramatic cold snaps that spike heating demand.
The biggest chills — compared to what’s normal — will be in the Southeast and South central zones. That’s good for NG demand, because people in these areas are less acclimated to the cold. They reach for the thermostats more quickly.
Temperatures in the Pacific Northwest may be warmer than normal. But that doesn’t dent the bullish case for NG. Weighted for population, temperatures will be one degree below normal, says Bastardi.
The extra snow will also make it feel more wintery. Boston may get 50-60 inches of snow compared to an average of 41, says Bastardi. New York may get 30-40 inches against an average of 25. And Washington, D.C., could see 20-30 inches vs. an average of 16. The Deep South will also see above-average snowfall. “This could be a wild winter, and it could last into March or April,” says Bastardi.
Why cold is on the way
Like a market quant, Bastardi makes his forecasts in part by looking at patterns shaping up at the moment, and then checking what normally follows. Right now, the closest matches are the winters of 2002-2003 and 2009-2010. The latter brought the early February blizzard dubbed “Snowmageddon.” That dumped over 35 inches of snow on parts of the Northeast. The 2002-2003 winter was the coldest in about decade for many parts of the country.
Another factor pointing to a cold winter is a drop in sunspots. This is called the “solar minimum.” Every eleven years, sunspot activity drops sharply, reducing solar radiation, which affects the weather.
Not all meteorologists buy this theory. But Bastardi believes solar minima can lower the Earth’s temperatures. So does his fellow meteorologist Michael Mann, a professor of atmospheric science and the director of the Earth System Science Center at Penn State. Mann thinks solar minima can affect weather patterns in a way that shifts the jet stream, influencing regional weather conditions.
I like to check in with Bastardi at WeatherBELL Analytics for a medium-range winter forecast every year, because he’s not afraid to deviate from consensus, and he’s often right. But he’s not the only one forecasting a big chill. The Farmers’ Almanac predicts “teeth chattering” cold and with plenty of snow. It also says winter conditions may hang on through the start of springtime.
Natural gas stocks
U.S. natural gas inventories are around 19% below the five-year average. S&P Global Platts, a provider of energy and commodities information, expects storage to rise but only hit 3.3 trillion cubic feet. That would be the lowest level to the start of the heating season since 2005. This sets up natural gas stocks for a bump in a cold-winter scenario. Here are five to consider.
Marcellus and Utica shales
These two shales running through Pennsylvania, Ohio and West Virginia are huge. They hold well over a quarter of the nation’s natural gas. The problem is, pipeline constraints make it difficult to get it to customers. But that’s changing. New pipelines and NG-fueled power plants are coming on line in the area this year. This could boost demand and prices. Here are three companies that could benefit.
Cabot Oil & Gas
As an early mover to the Marcellus, Cabot Oil & Gas (COG) locked in some of the best acreage and royalty rates. So it has super-low production costs. The break-even price of NG for Cabot is below $2 per thousand cubic feet (Mcf). NG recently traded closer to $3. Cabot has well over a decade of profitable drilling ahead of it, says Morningstar analyst Jeffrey Stafford, who has a four-star rating on this stock, out of five. He expects production to grow sharply over the next few years.
Thanks to the purchase of Rice Energy late last year, EQT (EQT) is the biggest natural gas producer in the country. This should make EQT a popular name among investors and traders when sentiment toward this group improves. The purchase of Rice Energy allows EQT to drill longer wells, which brings down costs. Production increased 83% in the second quarter, but net income took a hit in part because of an impairment charge related to some asset sales.
Antero Resources (AR) is another big NG player in the Northeast. It produces natural gas in the Marcellus Shale in West Virginia and the Utica Shale in Ohio. It has about 40% of the “liquids-rich” acreage in these formations. “Liquids-rich” means NG is mixed with other hydrocarbons like ethane, propane and butane.
Like Cabot, Antero is hurt by pipeline constraints. Completion of a pipeline called the Mariner East 2 in the fourth quarter will help. The company recently posted robust annual production growth of around 15%.
A Haynesville play
Hodges Capital Management energy sector analyst Mike Breard prefers Haynesville Shale plays to those in the Marcellus and Utica formations. Haynesville plays are closer to liquid natural gas (LNG) export and petrochemical companies in the oil patch and along the Gulf coast. They’re also closer to Mexico, which buys U.S. NG.
And they don’t suffer from the pipeline constraints. “Haynesville went through a period where infrastructure was overbuilt,” explains Roland Burns, the CFO of Comstock Resources (CRK) which produces NG there. Then production declined. So now the Haynesville is “crisscrossed” with under-used pipelines, says Burns.
Dallas Cowboys owner Jerry Jones, an energy baron, recently merged some of his oil holdings with Comstock. This seems like a good marriage. Jones’ holdings didn’t have a lot of development potential but they produce a lot of cash. Comstock was short on cash. But its properties have a lot of room for development. “We are now ramping up our drilling program,” says Burns. Comstock should move to five rigs next year from three now, which could increase Comstock’s NG production by 50% next year.
Election day will be a big deal for Colorado energy companies and their investors. A ballot proposition would limit energy production closes to homes and “vulnerable areas,” putting most of Colorado off limits. But it’s not clear voters will approve this. Political candidates for top offices on both sides of the aisle do not endorse this proposition.
“You aren’t seeing much support for it because I think it has gone too far,” Highpoint (HPR) CEO Scot Woodall said in his company’s August earnings call.
Here is another obstacle: Woodall notes another initiative would force the state to reimburse land owners for losses caused by the approval of anti-drilling initiative, and this would cost the state $26 billion.
Highpoint produces oil and natural gas in Colorado’s Denver-Julesburg Basin. NG will make up a little under half of production in the third quarter. So besides getting a boost from improved sentiment towards NG companies if a cold winter rolls in, Highpoint shares will also benefit if Colorado rejects the anti-drilling initiative. Insider executives just put about $450,000 into this stock, one reason I recently suggested it in my stock letter.
North American NG companies may also be more than just a trade. They will benefit from several trends: More electric vehicles, the ongoing decline of coal to fuel power plants, and the export of LNG by companies like Cheniere (LNG), Tellurian (TELL), Golar LNG (GLNG), and Sempra Energy (SRE).
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