Shale gas stocks lose edge over S&P 500 in Q1; drillers turn to ESG for momentum

Analysts anticipate the major U.S. pure-play shale gas producers will report increased free cash flows for the first quarter of 2021, reaping the benefits of higher winter gas prices after they kept their spending low and stuck to maintenance drilling plans with little growth in natural gas volumes.

"Capital discipline, free cash flow generation, and shareholder returns remain priorities, with double-digit production growth largely in the past," Raymond James & Associates oil and gas analyst John Freeman told clients April 23.

The stocks of shale gas exploration and production companies outperformed broader indexes in 2020, but their year-over-year comparisons have shrunk as shale oil producers and the larger economy have recovered from the 2020 crash in crude prices.

Pure-play gas drillers have been burned repeatedly by spending and producing more than the gas market could handle. Sanford C. Bernstein & Co. gas analyst Jean Ann Salisbury thinks the companies have learned their lesson and are waiting for higher prices to increase their activity.

"This [exploration and production] capital discipline should also be bullish for gas price if people believe it," Salisbury said March 23. "If we are only adding around half as much free gas as before, it suggests dry gas (Appalachia and Haynesville) should be the marginal growth, and Appalachia doesn't want to grow any more below $3/Mcf."

With volume growth no longer making an impression on investors, natural gas producers are turning to environmental issues to pitch the fuel as part of a lower-carbon future.

After overseas customers began canceling LNG contracts because of uneasiness over the amount of methane emitted in the production and transportation of the gas, shale gas producers, including the U.S.' largest driller, EQT Corp., began signing deals to certify their gas as "responsible." Mentions of environmental, social and governance issues, primarily the "E" component, more than doubled year over year in fourth-quarter 2020 earnings calls and reports.

"We believe the move to quantify, reduce, and track the greenhouse gas emissions profile of natural gas will become an increasingly important competitive factor in the global energy market as customers and governments are increasingly interested in understanding and controlling their emissions and 'responsibly sourced gas' (RSG) may be able to command a premium in the future," analysts Benjamin Salisbury and Josh Price of Washington, D.C.-based Height Securities LLC predicted April 16.

The basket of significant public shale gas E&Ps has lowered its direct greenhouse gas emissions, including methane, by more than 50% on average over the past five years, according to Trucost, a climate data provider. But more reductions are possible: despite the decline in the sector's average, four of the nine drillers examined have increased their direct emissions, as a function of revenue, over the past five years, according to Trucost.

One advantage most of the shale gas drillers enjoy is location. They are exploiting a youthful basin in Appalachia where wells and pipelines are less than two decades old, the oil and gas consultants at Rystad Energy noted April 22.

"As the basin becomes more mature and modern ESG best practices are implemented, we anticipate Appalachia to improve further in its CO2 intensity dimension in the next three to four years," Rystad senior analyst Emily McClain said.

Trucost is part of S&P Global Market Intelligence.