Seven Natural Gas Plays to Buy in the Upcoming Turbulence

By Michael Brush
Exclusively for InvestorIdeas.com
July 26, 2007

Here we go again. Just like last fall, the weather is not cooperating with investors in natural gas stocks – and the weather is winning.

Last fall, unseasonably warm weather compounded the normal seasonal buildup of natural gas in storage that occurs during the “shoulder months.” That’s the time during the fall when there is a lull between summer cooling demand for energy and winter heating demand.

Natural gas prices fell. Investors panicked. The shares of North American producers plummeted. But then a cold snap came and both the price of natural gas – and the related stocks – rebounded nicely.

Summertime, and the weather is cool

This time around it’s too cool, not too warm. Summer temperatures haven’t risen high enough in North America to spark serious demand for electricity to power air conditioners. Gas in storage has shot up, and natural gas plays have sold off.

Goodrich Petroleum (GDP) is off 18% from recent highs, falling to $30. Southwestern Energy (SWN) has fallen 20% to $40. Chesapeake Energy (CHK) has fallen 8% to $37.50. And one of our favorites, Panhandle Oil and Gas (PHX) is down 10%.

How long will this last? I don’t know – but I don’t think we have seen the bottom yet. “We cannot rule out a return to prices near 2006 lows as we believe storage levels may soon exceed last year's record levels,” says Lehman Brothers (LEH) energy analyst Thomas Driscoll.

Storms, heat and shortages

Part of the problem is that it’s a long time until the winter cooling season. Unless we get some really hot weather in North America or, heaven forbid, a hurricane damages significant capacity, don’t expect a sustainable reversal any time soon. Keep in mind that the most powerful hurricanes tend to happen in September and October.

But also remember that there’s still an underlying shortage of natural gas in North America because of production declines. The number of rigs at work in North America has doubled over the past 18 months “but there has been little production benefit,” says one analyst. So while traders are beating down natural gas plays, the long-term trend is still in your favor if you are long. “There is a disconnect between those who believe in the long-term trends for natural gas, and the short-term trading that goes on,” says the analyst.

The key takeaway: Natural gas stocks look tempting now that they have pulled back, but even if you are too early you will be ok in the long run. So I’d suggest two tactics.

• First, begin building positions on pullbacks. In the recent weakness I’ve added long exposure to Chesapeake, Goodrich and Toreador Resources (TRGL). That doesn’t mean I think a bottom is in place on any of these stocks. But they are down enough to begin accumulating.
• Second, traders can try to profit from what I’m guessing will be a lot of volatility in news flow in the coming weeks around storage levels, heat waves and possibly hurricanes.

The best insider plays

But which stocks to focus on? So far, I’ve only seen buying in two names on weakness: Goodrich and Cheniere Energy Partners (CQP), a limited partnership that pays a hefty 8.7% dividend backed by expected cash flows from liquid natural gas (LNG) plant now under construction in Louisiana.

But many of our insider-buy natural gas names are now trading down towards levels where insiders have purchased in the past. So my game plan is simple. I’d use their past purchases as a guide to where to buy in the coming weeks. Here’s a quick roundup.

Goodrich Petroleum

What it does : Goodrich produces natural gas in the Cotton Valley Trend in Texas and Louisiana (http://www.investorideas.com/insiderscorner/Articles/Four_Natural_Gas.asp). Thanks in part to a series of aggressive acquisitions over the past two years, Goodrich was able to increase production and revenue by 59% and 64% in the most recent quarter.

Where the insiders buy : Insiders own about 32% of the stock and they’ve been regular buyers on dips over the past year. Most recently, they picked up $1 million worth at about $29 in the weakness this week.

Chesapeake Energy

What it does : Chesapeake was one of the first energy companies to foresee the looming supply-demand imbalances of natural gas in the late 1990s so it got a jump on competitors in snapping up cheap reserves -- primarily in Oklahoma and Texas. Now it is the third largest independent producer of natural gas in the U.S.

Where the insiders buy : There has been some straight selling and options-related selling this year, but chief executive Aubrey McClendon is a steady and faithful buyer on pullbacks. He’s purchased $191 million at an average price of $28.47 over the past 18 months – most recently a $3.5 million purchase at an average of $34.84 in June, according to InsiderScore.com.

Cheniere Energy Partners LP

What it does : Cheniere Energy Partners is a limited partnership that is developing an LNG processing plant in Louisiana through a subsidiary called Sabine Pass LNG. Capacity has been contracted out for 20 years on a take or pay basis by Total (TOT), Chevron (CVX) and Cheniere Marketing, a subsidiary of Cheniere Energy which is also a partner in the Sabine Pass project. At recent prices, the partnership pays out distributions that give you a yield worth 8.7%.

Where the insiders buy : Charif Souki, who is chief executive at both Cheniere Energy Partners and Cheniere Energy, bought about $130,000 worth of the Cheniere Energy Partners units for around $18.50 to $19 in June and July.

Linn Energy (LINE)

What it does : Linn Energy is an “upstream” master limited partnership – meaning it holds reserves for exploration and production, as opposed to the pipelines and processing plants you find in most energy MLPs (http://www.investorideas.com/insiderscorner/Articles/072407.asp). It offers a 6.2% distribution yield.

Where the insiders buy : Insiders were regular buyers at much lower prices last year, and finance chief Kolja Rockov bought $936,000 more in mid-July at about $37.40.

Panhandle Oil and Gas (PHX)

What it does : Panhandle Royalty is a small natural gas company with solid holdings in two of the hottest natural gas plays around: the Fayetteville Shale in Arkansas and the Woodford Shale in Oklahoma (http://www.investorideas.com/insiderscorner/Articles/011107.asp).

Where the insiders buy : Robert Robotti, a money manager at Robotti & Company Advisors who is on the board at Panhandle, has been a buyer for the past year at about $18 to $20.

Toreador Resources (TRGL)

What it does : Toreador Resources is a small energy company with vast, potential energy reserves in emerging countries like Romania, Hungary and Turkey. The company is controversial because of a string of unmet promises but it is now under new management, and it is starting production in Turkey (http://www.investorideas.com/insiderscorner/Articles/060807.asp).

Where the insiders buy : Since the end of March insiders have purchased $2.5 million worth of the stock at prices between $13.19 and $18.44, with most of the buying in the $13-$14 range, according to InsiderScore.com. That’s a significantly bullish signal for a company with a market cap of just $300 million.

Cimarex Energy (XEC)

What it does: Cimarex Energy has a solid collection of mainly low-risk assets in the Anadarko Basin, Permian Basin and South Texas, and along the Gulf Coast and offshore in the Gulf of Mexico. Cimarex likes to “grow through the drill bit” which means it has lower debt levels, but problems with production and development get magnified since there are few acquisitions in the mix to help make up the difference (http://www.investorideas.com/insiderscorner/Articles/121406.asp).

Where the insiders buy : Insiders were sellers recently at $41-$42, but they were even bigger buyers earlier this year at $36-$38.

The bottom line : Natural gas prices could temporarily sink much lower than anyone expects, which will hurt your positions. So be prepared for this, if you buy now. One sign that a bottom may be near: Watch for a big player like Chesapeake to announce it is shutting in some production because natural gas prices are too low. That will shake up the market – but it could also market a bottom like it did last fall.

Disclaimer
At the time of publication, Michael Brush was long Goodrich Petroleum, Chesapeake Energy, Cheniere Energy and Panhandle Oil and Gas, and Toreador Resources. Mr. Brush is an independent columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About Insiders Corner: http://www.investorideas.com/insiderscorner/. InvestorI deas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp . InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.

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