Tickers in this Article: CHK, EOG, DVN, UPL, HAL, BHI
The United States has still not embraced natural gas anywhere to the extent it should as part of its energy infrastructure, and yet the major gas producers keep drilling and pumping away. The exploitation of shale gas reserves has been a resounding success, but the impact on prices has been severe - from peak prices in the mid-teens in 2005 and 2008 (and talk of possible "peak gas" and gas shortages), natural gas prices for December now languish below $4. That makes it tough to make a buck in the gas business.

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A Mixed Bag In Calendar Q3
At first glance, there does not seem to be much cause for worry in the gas patch. Netting out the impact of derivatives and other hedges, Ultra Petroleum (NYSE:UPL) reported revenue growth of 15%, Chesapeake (NYSE:CHK) posted 23% growth, Devon (NYSE:DVN) delivered 13% growth and EOG (NYSE:EOG) saw revenue rise about 9%. In the cases of Ultra and Chesapeake, output was likewise strong, with growth of 21% and 23%, respectively.

Profitability was also relatively solid on the whole. Ultra saw operating income more than double (up about 120%), while Chesapeake logged 11% EBITDA growth and Devon saw EBITDA grow 22%. EOG was admittedly a laggard here, though, as EBITDA fell almost 9%.

Can They Keep This Up?
Despite decent near-term performance on the whole, these reports seem to be stirring up a host of concerns among energy investors. EOG's stock took a beating, largely due to a significant revision in forward production guidance. Given that nobody seems to be expecting a meaningful price rebound, there is not much optimism that EOG will get back in prices what it is giving up in volume - and a transition to a more liquids-heavy portfolio will take time.

Likewise, Devon is working hard to reorient towards onshore liquids, but close to 70% of the company's production is in natural gas. Although the company should be getting credit for cleaning up its balance sheet and having a relatively high exposure to oil (as well as double-digit growth potential here), it seems like investors do not want to move past worrying about natural gas. (For more, see The Story On Natural Gas Liquids.)

For Chesapeake, the worries go a little deeper. The company is trying to ramp up its liquids production from about 10% of production today to as much as 30% by 2015. What's more, the company has said that, although it intends to maintain activity in the Barnett and Marcellus shales, it will scale down production in Haynesville without higher gas prices - a sensible decision given that Haynesville production tends to be much more heavily weighted towards "dry gas". On the other hand, Chesapeake continues to follow a very aggressive lease acquisition strategy, creating a binary outcome for investors. If energy prices do well, Chesapeake will have fat times, but a sustained period of low prices could seriously threaten the company's liquidity. (For related reading, see Operators Fill In The Blanks On the Niobrara Shale.)

With Ultra Petroleum, it is not really clear that there is much to worry about beyond the price of gas. Ultra is committed to natural gas and seems to have found a good balance in its lease acquisitions. It also does not hurt that Ultra is extraordinarily efficient. With costs of just $2.52 per mcfe - which the company sees rising to as much as $2.70 in the fourth quarter - Ultra can make a buck when many of its rivals would be bleeding and curtailing unprofitable production. So perhaps that is their biggest worry - the ability to maintain a cost profile that has them in the black even if gas prices go ridiculously low.

The Bottom Line
With companies like EOG and Chesapeake talking about curtailing gas production, investors are seeing the energy cycle play out as it always does - higher production hurts prices up to a point where companies decide to cut output. Time will tell, though, whether this leads to any real decline in drilling activity and tougher conditions for the likes of Halliburton (NYSE:HAL) or Baker Hughes (NYSE:BHI). Shale gas wells are expensive, but they tend to have short lives (or at least steep drop-offs).

In the meantime, it seems to make sense to gravitate toward companies with more oil in their portfolio, or at least rock-bottom cost structures in natural gas. The U.S. may someday wake up to the imminent practicality of using more of its abundant natural gas resources, but that is not going to happen tomorrow and the wait could be long and painful for indiscriminate investors. (For more, see Oil And Gas Industry Primer.)

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