By Bob Moriarty | 6 June 2008
I don’t think I would be telling tales out of school to point out that markets are often irrational. It’s been said that markets can stay irrational a lot longer than you can stay solvent so the fact that markets are irrational isn’t always a buy signal. However once a market turns, it tends to continue in the same direction.
Crude oil can be measured in BTUs and is used to provide energy. Natural gas is little more than an alternative form of the same energy and can be measured in BTUs. If anything, natural gas is generally a better form of energy so it should carry a premium.
If crude oil is selling for $120 a barrel, natural gas SHOULD be selling for $20 per mcf on a BTU basis. As I write, Light Sweet Crude is being quoted at $125.60 down from about $137 a week ago. Natural Gas is being quoted at $12.27. By the time you read this, each will have changed but my point is that the ratio should be 6-1 on a BTU basis and it’s 10.23-1. Last week it was almost 12 to 1.
Ratio investments are often a good idea when markets become too irrational. Energy is energy and you can look for natural gas to go up and oil to come down. But ratio investments work even in declining markets. If you short crude and go long natural gas, the investment would work as long as crude goes down faster than natural gas. And I look for lower crude in the months ahead even if Peak Oil was in May of 2005. Crude got ahead of itself.
I was looking at our advertisers and trying to figure out a good natural gas play and I think I found a good one. Enterprise Oilfield Group (E-V) was the subject of a piece I did exactly a year ago. For two years, natural gas prices have been dreadful both on their own and especially in comparison to crude. I think the ratio peaked last week and for certain natural gas has been going up.
Enterprise operates a fleet of over 260 trucks and various pieces of heavy equipment in Central Alberta providing oilfield services. While 11 of Enterprise’s direct competitors have gone out of business in the last year, oilfield work is picking up and Enterprise is still highly profitable.
Since the downturn in natural gas prices starting about two years ago, drilling activity in the Canadian oil patch has hit a 10 year low. As oil sands production comes on line, more and more natural gas will be required in the Ft McMurray area. Production of a barrel of oil from the tar sands requires 1000 cubic feet of natural gas. Enterprise has positioned itself perfectly to take advantage of the expected upsurge in oilfield activity as oil from tar sands becomes economic again. And anything selling at a PE of four can’t be all that bad.
Williams' Stock Could Be Piping Hot
By Naureen S. Malik, Barron's | 6 June 2008
Shares of the natural gas conglomerate offer a combination of utility-like stability, with a bit of a commodity-price kicker. Once on the brink of bankruptcy thanks in part to a volatile energy-trading business reminiscent of Enron's, Williams Cos. (ticker: WMB) has taken a sober turn. In recent years, Williams has shed some of its troubled businesses and revamped itself as a natural gas explorer, processor, and pipeline company at a time when commodity-based companies of this kind are in vogue on Wall Street.
This integrated three-tier model may seem troubling to those seeking a pure-play commodity stock. But investors can capture stable returns similar to utilities from the company's regulated pipelines business and take advantage of the rallying natural gas market through Williams' fast-growing exploration-and-production business. William's third business— which processes natural gas into methane, the primary form of gas, as well as by-products such as butane and propane— acts as a natural hedge against the E & P business.
At $39.16, the stock has gained 18% over the past 12 months and offers a 1.2% dividend yield. "Williams is having a Renaissance" with an E&P business that will grow in the double-digits for the next five years, says RBC Capital Markets senior equity analyst Lasan Johong. Things weren't always this good. Williams's stock, a high-flyer in the late 1990s, fell to less than $1 a share in mid-2002 after the dual collapse of its flashy energy-trading and the fiber-optics communication businesses.
Despite recent stock gains, RBC Capital Markets' Johong says that "to some degree Williams is also undervalued [compared to other E&P players], but they are slowly but surely overcoming investor angst" over its three-headed business model. Based on 2009 estimates, Williams is trading 6.4 times enterprise value-to-earnings before interest, taxes, depreciation and amortization, notes Johong. This valuation is a discount compared to peers Oneok (OKE) (7.2x) Sempra Energy (SRE) (7.7x) and Southern Union (SUG) (8.6x).
Known for rattling the cage at other companies, activist shareholder Carl Icahn has maintained a fairly steady— and silent— investment in Williams for the past two years. Icahn Associates ended the first quarter with 3.9 million shares, or a stake of less than 1%. While Williams is not a large holding for Icahn, he would certainly step up in the wake of missteps or missed opportunities, says Calyon Securities energy analyst Gordon Howald. "That's a real positive."
Williams' three businesses should continue to churn out strong profits and margins given robust industry fundamentals. The company, which operates 14,200 miles of pipeline across the U.S., is expanding its main Transco pipeline that stretches from Texas into New York's metropolitan area. Regulators recently approved a rate increase for Transco. A new western pipeline is still in planning stages. Williams is also solidifying its role as a dominant collector and processor of natural gas coming out of the Canadian oil sands and the deep water of the Gulf of Mexico.
Williams has also placed some of its midstream and pipeline assets into publicly-traded master limited partnerships— Williams Partners (WPZ) and Williams Pipeline Partners (WMZ)— that have allowed the company to raise capital and lower costs. MLPs pay out their extra cash to investors in the form of high dividends. Plus with $2.2 billion in cash, Williams has plenty of liquidity to continue buying back stock and to expand its three businesses.
At a Glance: Williams Cos.
Stock Price: $39.16
52-Wk High: $39.93
52-Wk Low: $26.82
Market Cap: $23.01 billion
Est. 2008 EPS: $2.10
2009 P/E: 15.9x
Est. Long-Term EPS Growth: *19.5%
Est. ('09/'08) EPS Growth: 17%
Revenue (trailing 12 months): $9.15 billion
Dividend Yield: 1.2%
Chairman/Chief Executive Officer: Steven J. Malcolm
Headquarters: Tulsa, OK
*Based on analyst estimates looking ahead three to five years.
Sources: Thomson Reuters, Barron's Online
Williams Chief Executive Officer Steve Malcom told Barron's Online that the company's strong growth rate is "absolutely" sustainable. He notes the company has identified more than ten years of natural inventory for drilling opportunities. "We grew production the last four years at a rate of excess of 20%. We expect to grow our production at a rate certainly higher than most, and all of our growth is through the drill bit," Malcolm says.
Williams's natural gas production growth rate is the fourth-fastest in the U.S. after fellow E&P companies Anadarko (APC), Chesapeake Energy (CHK) and XTO Energy (XTO). The company is now U.S.'s 12th largest producer of natural gas with proven reserves of 4.1 trillion cubic feet of natural gas equivalent. More than 60% of those gas reserves are in the emerging hot natural gas play in Colorado's Piceance Basin with the remaining mainly split between San Juan and the Powder River Basin.
The discount for Rocky Mountain natural gas compared to New York Mercantile Exchange futures has narrowed from $6-$7 to $1-$2 thanks to the newly opened pipeline from the region. Nymex natural gas contracts have gained 67% this year alone to $12.519 per million British Thermal units. Contracts closed at a record high of $15.378 on Dec. 13, 2005.
Calyon's Howald says that Williams has a "very low risk strategy" for excavating gas. It concentrates on drilling more wells in proven areas. For example, once two wells have been successfully drilled 120 acres apart, the company will then drill midway between those to tap into additional reserves. CEO Malcolm notes the company's new rigs can now drill 22 wells from one pad instead of four-to-six wells. These are mainly horizontal wells that create an underground network. It takes these new rigs ten days to drill a single well instead of 30 days.
As a result, Williams' finding-and-development costs are just $1.77 per million cubic feet over the past three years versus the industry average of $2.89. Part of that is because Williams drills for gas out of coalbed methane rather than more-expensive shale drilling. That means Williams will continue to be highly profitable should longer-term natural gas prices fall to $7-$9 as CEO Malcolm expects.
About half of Williams' production is hedged in 2008 and 2009 and all of the recent ones are collar contracts that allow for a degree of fluctuation, says Malcolm. The company could see additional upside over the next few years as unfavorable contracts— less than 10% of 2008 and 2009 production— minted in 2001 and 2002 at around $4 expire. Analysts surveyed by Thomson Reuters expect earnings-per-share to grow from $1.72 last year, to $2.10 this year, to $2.46 in 2009. Certainly, a pullback in natural gas prices and demand would subdue this growth picture. However, Williams' diverse business model is worth getting pumped up over.
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Normxxx
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