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The Intelligent Investor: Is Natural Gas a Flaming Buy? WSJ.com

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THEINTELLIGENTINVESTOR

Orderareprintofthisarticlenow

UpdatedApril27,2012,2:05p.m.ET

AFlamingBuy?NaturalGasWon'tStayLow
Forever
By JASON ZWEIG

Therearetwokindsofinvestors:thosewhorunawayfromafireandthosewhoruntowardit.
Toinvestinnaturalgasstocks,youhadbetterbethekind
whorunstowardafire.

ChristopheVorlet

Priceshavecollapsedfornaturalgasandforthesharesof
companiesthatproduceit.Everyday,theU.S.naturalgas
marketisfloodedwithanaverageof3billioncubicfeet
morethanthenationconsumes.Sharesofgascompanies
aredowninarisingstockmarketbyanaverageof22%
overthepastyear.EvenWarrenBuffettlostmoneywhen
naturalgaspricesfellfurtherandfasterthanheexpected.

Inshort,thenewsaboutnaturalgasisawfulexactlythe
typeofconflagrationthatgrowthinvestorshate,butvalueinvestorslove."Everyonewhohasabrainshould
bethinkingofhowtomakemoneyonthisinthelongerterm,"therenownedinvestorJeremyGranthamof
GMOwroterecently.
RelatedReading
MarketBeat:NaturalGasRises2.8%

Inmid2008,naturalgastradedabove$10perfutures
contracttodayyoucanbuytheequivalentfor$2.Thefuel
issocheapthatifyoucouldsomehowmagicallytransportit
toEuropeorAsia,youcouldsellitforfourtoeighttimes

whatyoupaidforithere.
Newdiscoveriesandinnovativedrillingtechniques,alongwiththerecentbalmywinter,haveledtoavast
oversupply.Nationwide,inventorieshaverisen56%overthepastyear,accordingtotheU.S.Energy
InformationAdministration.
Themarketissoawashinnaturalgas,accordingtomanyanalysts,thattherecouldbenospacelefttostore
thestuffintheentireU.S.bythisautumnunlessdemandsurgesorproducerssealtheirwells.
CharlesMaxwell,anenergyanalystatWeeden&Co.with45yearsofexperience,says,"Icannotinmy
memoryrecallatimelikethis,whenwehavecreatedasurplusthatmaybebeyondourcapacitytostore."
Historically,saysDavidTameron,ananalystatWellsFargoSecurities,naturalgashasbeenabout10times
cheaperthancrudeoil.Attoday'sdepressedprices,gasisroughly50timescheaper."Thatdiscountis
enormousandunsustainable,"hesays."IfyoulooktothefutureoftheU.S.,thefreemarketwillturn

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5/2/12

The Intelligent Investor: Is Natural Gas a Flaming Buy? WSJ.com

naturalgasintotheanswerforthiscountry'senergyproblems."
Inwhatcouldbeamultiyearshift,electricalutilitiesandtruckingcompanies,amongothers,arealready
switchingfromcoalordieseltonaturalgasandmoreindustriesareboundtofollowifitstayscheap.
Eventually,theriseindemandisboundtodrivepriceshigher.Thentheprofitabilityofthecompaniesthat
discoverandproducenaturalgaswillheatup.
"Investorscanmakebigmoneylongerterm,"saysDanRice,comanageroftheBlackRockEnergy&
Resourcesfund,"butyoutellmehowmanypeoplehavehorizonslongerthanthreeorsixmonths."
Mr.RicelikesRangeResources,aFortWorth,Texasbased
producerwithbroadexposuretothe"sweetspots,"orrich
fields,intheAppalachianregionthatproducegasatvery
lowcost.Thatshouldenableittosurviveaprolongedperiod
ofdepressedpricesforgas.

AssociatedPress

RangeResourcesandEncanaareamongthe
naturalgasproducersanalystslike.Above,pumps
usedtoreleasenaturalgasataRangeResources
siteinClaysville,Pa.

Rangeisoneofthefewnaturalgasplaystohavegoneup
overthepastyear,butitsprofitsaresodepressedthatthe
stockistradingatatripledigitmultipleofearnings.Still,
Mr.Riceestimatesthecompany'sassetsareworthupto
$200pershare.

Mr.MaxwellisafanofEncana,anAlbertabasedproducer
whosesharesaredown36%overthepastyear.The
companyistradingatslightlyunderitsbookvalue,orthe
surplusofwhatitownsoverwhatitowes,andatfourtimesitscashflowmakingitstatisticallycheapon
twokeymeasures.MuchofitsgasreservesareinnorthernCanada,apotentiallyrichsourcethatMr.
Maxwellcalls"oneofthegreatestgasplaysofthecoming30years."
Ifyoucanstandnotjustriskbutcontroversy,youmightevenconsiderChesapeakeEnergy.Itschief
executive,AubreyMcClendon,borrowedmorethan$1billiontotakedirectpersonalstakesinthecompany's
wells.Afterthesearrangementswerewidelycriticized(andthestockfell27%inthepastmonth),
Chesapeakesaidtheywon'tberenewed.
Atatteredstockinabatteredindustry,Chesapeakerecentlytradedatthreequartersofbookvalueandless
thanfourtimescashflow,accordingtoStandard&Poor's.Thecompanyhasextensiveholdingsingasrich
shale,analystssay.Chesapeakehaslotsofdebtandnotmuchcash.It'sanextrariskybetthatnaturalgas
willreboundsoonerratherthanlater.
Don'ttouchthesestocksunlessyoucanwithstandthehighprobabilityofgettingashorttermscorching.
There'salsoalesserriskthatsomeofthesecompaniescouldflameoutcompletely.Investorshereneed
patience,deeppocketsandanimplacabletoleranceforpain.
intelligentinvestor@wsj.comtwitter.com/jasonzweigwsj

AversionofthisarticleappearedApril28,2012,onpageB1insomeU.S.editionsofTheWallStreet
Journal,withtheheadline:AFlamingBuy?NaturalGasWon'tStayLowForever.

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