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In This List

Worried investors steering clear of shale gas E&Ps

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Worried investors steering clear of shale gas E&Ps

The nation's largest natural gas drillers are off to a profitable start in 2017, but their stocks have been crushed as investors worry over longer-term trends.

Nine of the top 10 independent natural gas producers by volume reported adjusted profits in the first quarter, and gas prices are expected to hover near $3/MMBtu, on average, for the next three years. Combined with a supportive Trump administration interested in streamlined pipeline permitting, the sector is surrounded by relatively good news considering drillers have driven the cost to get gas out of the ground down to $1/MMBtu or less.

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Nonetheless, an equally weighted index of the stocks of those same 10 producers has lost 19% since the year began, as investors look elsewhere. By comparison, the benchmark S&P 500 index has gained nearly 8% since the year began. Of weak consolation, the S&P Oil & Gas Exploration and Production Index of companies has lost 22.5% over the same period.

Fresh off a marketing tour, Mizuho Securities USA LLC gas analyst Timothy Rezvan summed up the sentiment of the investors he met. "Every long-only investor we spoke with has a negative view of natural gas E&Ps, and is content to play defense with high quality oil E&Ps," Rezvan said in a June 11 note to clients. "Zero investors bullish on the commodity or on gassy E&Ps."

Investors are worried by several "grey clouds on the horizon," Rezvan said: the resurrection of the Haynesville Shale nearest to LNG export terminals, the unknown of how much associated gas from Permian oil drilling will hit the market, and the uncertainty of the timing of pipeline takeaway capacity out of the Marcellus Shale.

Rezvan's top pick among the shale gas producers is Appalachian shale driller Rice Energy Inc.

"[The] space has been under significant pressure over the last month as equities have sold off 10-20% on weakness in the front end of the curve, combined with a steep selloff in energy," analysts at energy investment bank Tudor Pickering Holt & Co. said June 8.

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That weakness may be creating a chance to pick up undervalued shares, TPH said, particularly if oil drilling, with its associated gas production, slows in a glutted global market.

"Equities are now generally discounting a price well below our current long-term deck ($3/Mcf)," TPH said. "We find it hard to see equities working if gas prices continue to fall, but we do sense that if crude remains weak investors may trade around gassy names as associated growth will slow dramatically."

Although bearish on natural gas producers as a group, TPH's still recommends two Appalachian shale producers as a buy: the 100% hedged Antero Resources Corp. and Pittsburgh's EQT Corp.

The outlook may not be as grim as analysts are making out, Sanford C. Bernstein & Co. energy sector specialist Alex Leung said June 8. "Bulls point to forecasts for hot weather as well as flattish Marcellus rig count since December (even though prices are down 20%+ from the $3.90 peak) as reasons to stay long."