Natural gas lineATTILA KISBENEDEK
Natural gas prices in the United States are near their lowest in a decade, and sliding. Yet despite Wednesday's declines, shares of gas drillers like Cabot Oil & Gas are trading on richer multiples than extractors of dearer oil.
Last year was supposed to see a recovery in the gas price. Many leases that forced firms to continue drilling even as prices plunged came to an end. And tighter pollution rules favour the use of gas in electricity generation. Yet the abundance of U.S. gas has pushed the price down by around a third over the past year to under $3 (U.S.) a million British thermal units – a quarter of its peak in July, 2008. On Wednesday alone, the price fell nearly 6 per cent.
Despite this trend, investors have looked kindly on independent gas-focused drillers. As of last week, the group was valued at an average multiple of around 15 times estimated 2012 earnings, against about 10 times for oilier counterparts, according to Bernstein Research. Firms such as EOG Resources and Range Resources enjoyed forward P/E ratios of over 20 times. And Cabot, the biggest S&P 500 gainer of 2011, was trading at around 30 times 2012 earnings. It would need profit to grow about three times faster than peers for the next five years to justify that valuation, Argus Research reckons.
Investors may have started to get the idea, selling Cabot off by more than 10 per cent on Wednesday and pushing Range Resources down 6 per cent. But a glance at the P/E ratios shows that's not enough to close the gap with oilier counterparts. It's true that improving techniques for extracting gas from rock, known as fracking, mean practitioners can make money at lower gas prices than before. And with estimated reserves roughly equivalent in energy terms to Kuwait's oil resources, U.S. gas firms can ramp up production fast.
Even so, valuations seem to rest on a surge in the price of gas, and that looks unlikely. Plenty of spare capacity is waiting to come online, capping any price increase. And drilling for more lucrative oil is producing plenty of waste gas, further boosting supply.
The gas price might surge if U.S. regulators banned fracking. But that would also put the kibosh on production. Gas producers can expect either fast output growth or much higher prices in the years ahead – but not both. The current valuations can't be justified, and the recent selloffs may be just the start.