Pullback In Natural Gas Offers An Opportunity

U.S. natural gas prices have hit a fresh six-week low, closing at $7.75/MMBtu on Monday with the Wall Street Journal saying that the market has lost momentum due to U.S. production topping 100 Bcf/day for the first time ever. The odds are now that ample U.S. production will be enough to meet local demand in the final months before winter arrives. Prices are likely to remain depressed unless there’s a breakout of storm activity in the Gulf of Mexico which could disrupt production.

Meanwhile, benchmark European gas prices have continued to fall, dropping nearly 9% on Monday to their lowest in two months thanks to European energy markets improving due to a combination of successful policy action as well as a price-induced demand response. Indeed, Germany’s economic minister Robert Habeck has revealed that the country’s natural gas storage levels are nearing 90% thus giving it a chance of weathering the winter season. He has, however, warned that gas storage will likely be empty by the end of winter.

Naturally, natural gas and LNG stocks have lost some momentum alongside the commodity they track. For instance, the United States Natural Gas Fund is down 20.3% over the past 30 days but is still 108.9% up in the year-to-date. However, the structural tailwinds are likely to continue outweighing “cyclical headwinds” as Strategas Securities LLC partner and head of technical analysis Christopher Verrone told Bloomberg. Investors should, therefore, use the latest pullback in gas stocks as a buying opportunity. Here are some top picks.

Cheniere Energy

• Market Cap: 42.1B
• YTD Returns: 64.0%

Cheniere Energy (NYSE:LNG) is an energy infrastructure company that primarily engages in the liquefied natural gas (LNG) related businesses in the United States. Cheniere is one of the few pure-play LNG companies in the United States; the company owns and operates the Sabine Pass LNG terminal in Cameron Parish, Louisiana; and the Corpus Christi LNG terminal near Corpus Christi, Texas. The company also owns Creole Trail pipeline, a 94-mile pipeline interconnecting the Sabine Pass LNG terminal with various interstate pipelines; and operates Corpus Christi pipeline, a 21.5-mile natural gas supply pipeline that interconnects the Corpus Christi LNG terminal with various interstate and intrastate natural gas pipelines.

Back in March, the DoE approved expanded permits for Cheniere Energy's Sabine Pass terminal in Louisiana and its Corpus Christi plant in Texas. The approvals allow the terminals to export the equivalent of 0.72 billion cubic feet of LNG per day to any country with which the United States does not have a free trade agreement, including all of Europe. Cheniere says the facilities already are making more gas than is covered by previous export permits.

EQT Corp

• Market Cap: 13.6B
• YTD Returns: 78.0%

EQT Corporation (NYSE:EQT) operates as a natural gas production company in the United States. The company produces natural gas, natural gas liquids (NGLs), including ethane, propane, isobutane, butane, and natural gasoline.

As of December 31, 2021, EQT had 25.0 trillion cubic feet of proved natural gas, NGLs, and crude oil reserves across approximately 2.0 million gross acres, including 1.7 million gross acres in the Marcellus play.

EQT Corp. has unveiled a plan centered on producing more liquified natural gas by dramatically increasing natural gas drilling in Appalachia and around the country's shale basins, as well as pipeline and export terminal capacity, which it said would not only boost United States energy security, but also help break the global reliance on coal and on countries like Russia and Iran.

Ovintiv

• Market Cap: $12.6B
• YTD Returns: 40.0%

Ovintiv (NYSE:OVV) is a Denver, Colorado-based energy company that, together with its subsidiaries, engages in the exploration, development, production, and marketing of natural gas, oil, and natural gas liquids.

The company’s principal assets include Permian in west Texas and Anadarko in west-central Oklahoma; and Montney in northeast British Columbia and northwest Alberta. Its other upstream assets comprise Bakken in North Dakota, and Uinta in central Utah; and Horn River in northeast British Columbia, and Wheatland in southern Alberta.

Back in June, Mizuho upgraded OVV to $78 from $54 (good for nearly 60% upside to current price), citing improving tailwinds.

Devon Energy

• Market Cap: $43.2B
• YTD Returns: 47.8%

BofA Analyst Doug Leggate has advised investors to focus on oil companies with potential to grow their free cash flows through consolidations or other cost reduction measures, naming Devon Energy (NYSE:DVN), Pioneer Natural Resources (NYSE:PXD), and EOG Resources (NNYSE:EOG).

Devon fits that playbook to a tee, and while Leggate issued his advice earlier in the year, the case for this is only growing stronger.

DVN stock has been one of the best-performing energy stocks thanks to strong earnings and continuing cost discipline including a variable dividend structure.

Following the merger with WPX Energy (NYSE:WPX) last year, the company announced fixed-plus-variable dividends, something that has gone down well with Wall Street. In the second quarter, Devon paid out up to 50% of free cash as a variable dividend, bringing the total dividend to $1.55 per share. The stable portion has been indifferent, currently yielding slightly more than 1%. But if the latest convertible payout is a sign of the future, shareholders could receive closer to 10% overall.

Some Wall Street analysts had earlier pointed to the potential for DVN to sport a dividend yield of as high as 8% by year-end. Devon has already exceeded that, and now sports a juicy 9.7% estimated forward dividend yield.

Chesapeake Energy

• Market Cap: $12.4B
• YTD Returns: 65.8%

Commodity price hedging is a popular trading strategy frequently used by oil and gas producers as well as heavy consumers of energy commodities such as airlines to protect themselves against market fluctuations. During times of falling crude prices, oil and gas producers normally use a short hedge to lock in oil prices if they believe prices are likely to go even lower in the future.

Unfortunately, hedging also means that these companies are unable to enjoy the benefits of rising gas prices and can in fact lead to hedging losses. However, some bold producers betting on a commodity rally hedge only minimally or not at all.

Tudor Pickering rates Chesapeake Energy (NASDAQ:CHK) a Buy, saying the company remains one of the few producers that remain relatively unhedged.

This might come off as an odd pick given Chesapeake’s history, but somehow makes sense at this point.

Widely regarded as a fracking pioneer and the king of unconventional drilling, Chesapeake Energy has been in dire straits after taking on too much debt and expanding too aggressively. For years, Chesapeake borrowed heavily to finance an aggressive expansion of its shale projects. The company only managed to survive through rounds of asset sales (which management is averse to), debt restructuring and M&A but could not prevent the inevitable--Chesapeake filed for Chapter 11 in January 2020, becoming the largest U.S. oil and gas producer to seek bankruptcy protection in recent years.

Thankfully, Chesapeake successfully emerged from bankruptcy last year with the ongoing commodity rally offering the company a major lifeline.

The new Chesapeake Energy has a strong balance sheet with low leverage and a much more disciplined CAPEX strategy.

The company is targeting $2 billion of FCF over the next 5 years, enough to improve its financial position significantly.

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