A warm winter spells opportunity for natural gas investors

Share prices are likely to come under pressure, creating great longer term outcomes

Canadian and American natural gas producers are suffering through the drop from US$10 a gigajoule only a couple of years ago to prices in the US$2.00 range today. For the higher cost or highly indebted natural gas producers, this will be a cold winter in financial terms. The other side of this ugly trend for traders is long term opportunity for investors.

The climate change charade is an absurdity with 135 years of data showing no measurable changes in Christmas climate with the maximum temperature in the lower 48 U.S. States continuing to lie within historic ranges. But the periods of warm winters pretty well always put downward pressure on natural gas prices and lower trading prices for natural gas stocks. Smart money takes advantage of this by adding to holdings of unlevered companies with low operating costs at bargain basement prices.

The so-called “energy transition” has consumed US$1.7 trillion of capital, seen 32% growth in capacity of renewable energy, seen rapid growth in electric vehicles (EV’s) and saw demand for oil rise 2%, more or less in line with global economic growth in an anemic economy throttled by excess sovereign debt, policy created inflation, and central banks all raising rates to curb growth hoping for an economic downturn large enough to slow inflation.

This creates an environment where energy investors will enjoy a fire sale of stocks of profitable companies with solid balance sheets. A bit of perspective on the popular political platform of NetZero before talking about stocks. The low-hanging fruit has long since been picked and further reductions in emissions (which will cause more harm than benefit) will see soaring costs.

To make wind and solar competitive with coal and natural gas on an unsubsidized basis and get to a grid that is 70% fueled by wind and solar will need natural gas prices of US$20 per mcf (equal to one gigajoule).

As the leftist governments deluded by their “climate change” nonsense keep encouraging wind and solar and with energy demand growing unabated, the environment will see upward pressure on natural gas prices. Coal prices are already in the $100 to $200 range and coal use is limited to areas where natural gas is unavailable or already very costly - Europe and Asia primarily - and coal is being replaced by renewables in Europe although the high cost of both renewables and gas and limited supply of natural gas in Europe has seen a resurgence in coal use in Germany, for example.

There is no shortage of either coal or natural gas worldwide. The desire of leftist leaders to replace coal and gas with wind and solar is akin to forcing a square peg into a round hole and has driven electricity costs to nosebleed levels in Europe while sensible policies in China and India continue to rely on coal and import LNG to fuel their economies, not deluded enough to think there is any economic or environmental benefit to wind and solar alternatives.

I doubt we will see natural gas at $20 a gigajoule in North America any time soon despite the nonsensical policies of the Biden and Trudeau administrations since both seem doomed to extinction at the ballot box, but significant demand for LNG should see demand for gas continue to rise and eventually manifest itself in higher prices. What would $20 gas mean for natural gas players?

Here are my estimates of the value of some more or less pure natural gas players with gas prices at $20 a gigajoule for an extended period, should that occur.

Peyto Exploration - annual cash flow of CDN$5.8 billion and value of CDN$140 a share.

Spartan Delta - annual cash flow of CDN$1.4 billion and value of CDN$44 per share.

Birchcliff Energy - annual cash flow of CDN$2.9 billion and value of CDN$87 per share.

Tourmaline Oil - annual cash flow of CDN$17 billion and value of CDN$245 per share

I am not suggesting that Canadian natural gas prices will rise to $20 a gigajoule any time soon, but remind investors that prices north of $10 a gigajoule existed only a few short years ago and that natural gas prices in Europe hit as high as US$70 a gigajoule in 2022 (in part a result of curtailment of supplies arising from Ukraine war) and are currently over US$14 a gigajoule.

Reality is that there is little elasticity of demand for fossil fuels generally and natural gas in particular, and shortages see very high prices and surpluses see prices collapse with consumption hardly budging in either case. For the leftist dream of a “renewables” powered world to obtain based on competitive economics devoid of taxpayer subsidies, gas prices will have to rise and CDN$20 a gigajoule is not only possible but in my opinion likely sometime in the next two decades and for a long period therafter. Energy is such a vital part of a country’s economics, taxpayers can ill afford to subsidize energy on the scale needed to bring about the much vaunted “transition” so I conclude that the transition will either fail in its entirety or drive natural gas prices higher.

One of my favorite blogs is the well-written and well-researched Doomberg energy blog on Substack where the writers argue that a worldwide “glut” of natural gas is likely owing to the supply response to demand for LNG and the massive natural gas reserves that exist in all fossil fuel basins including “associated gas” which is a by-product of oil production. That is certainly possible but in my opinion LNG puts a floor on natural gas but no ceiling since liquefaction costs US$2 to $4 dollars per gigajoule and seaborne transportation of LNG adds another US$1 to US$2 per gigajoule, and the costs of its distribution by pipeline at the importing countries terminals dont’ disappear.

A price of US$3 to US$6 per gigajoule is nicely profitable for the names I mentioned. A 2019 paper from Stanford University argues that natural gas supplies may be exhausted within decades, the opposite of the “glut” seen by Doomberg analysts. A recent Bloomberg article argues that Europe’s short term “glut” of natural gas is about to disappear. They can’t all be right.

Reality is simpler than either Doomberg or Bloomberg articles argue. Gas reserves are a function of price and more gas is available as the price rises. Doomberg is correct that the supply is virtually unlimited which is the foundation of its “glut” case, but wrong in its conclusion that unlimited supplies will lead to extremely low prices. Gas, unlike oil, is a local market with LNG the only outlier but LNG has intractable costs to liquefy and move the gas and no one will spend money to run LNG terminals at cash flow loss or run LNG carriers thousands of miles by sea at a cash flow loss. LNG is a floor on prices unless demand falls in importing nations or they find a lower cost alternative.

There are a lot of forces that affect natural gas supply and demand, weather perhaps the most important, and gas prices are likely to be volatile regardless of the thesis of “glut” or “shortage” pundits promote. But in my opinion, Adam Smith will prevail and the outcome will reflect supply and demand as they react to supply costs and alternatives for necessary energy consumption. That makes natural gas an attractive if dangerous area for investors and my bets are that gas producers will provide stellar returns over the rest of my lifetime.