Investors face a confusing situation in natural gas in 2010, with a weak fundamental backdrop conflicting with what seems to be an easy investment case being made for a rebound in the commodity.
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Natural Gas Bulls
The bull case for natural gas in 2010 rests on several arguments. The sharp drop in drilling over the last 18 months combined with the high decline rates of recent unconventional wells will lead to a sharp reduction in the supply of natural gas. Furthermore, demand for natural gas will get stronger once the economy recovers. (For a primer on the oil and gas industry, refer to our Oil and Gas Industry Primer.)
Also, demand for natural gas will be stronger on a long-term secular basis because it is one of the more environmentally-friendly fuels with lower emissions than other competing fuels like oil or coal.
Natural Gas Bears
Natural gas bears fear an abundance of supply due to the higher proportion of horizontal wells being drilled in North America. Since these wells are as much as five times as productive as vertical wells, this accounts for the phenomenon of flat production of natural gas despite the large drop in the rig count.
Even worse, the rig count bottomed in the summer of 2009, and the industry has started to drill again without waiting for the market to balance. So instead of production being flat, it will start to head up, boosting inventories and hurting the price of natural gas.
Players and Plays
Investors who are concerned about natural gas fundamentals in 2010 can still invest in energy by selecting exploration and production stocks that have most of its production and reserves in oil.
Resolute Energy (NYSE:REN) is a small cap company with the highest proportion of oil of any publicly traded company, with 91% of its proved reserves in oil. The company has properties in Utah that are involved with tertiary recovery operations.
Whiting Petroleum (NYSE:WLL) is also an oily name with extensive properties all over the U.S., including 88,000 net acres in the Williston Basin in North Dakota. The company is actively developing the middle Bakken formation in the Parshall and Sanish fields. Whiting Petroleum has 75% of its proved reserves in oil at the end of 2008.
Denbury Resources (NYSE:DNR) is also mostly oriented towards oil. The company operates the largest tertiary oil recovery operations east of the Mississippi River, which involves injecting carbon dioxide into older wells to stimulate further production. The company just announced the acquisition of Encore Acquisition Company (NYSE:EAC), another oily name, and estimates that the combined company has about 70% of its proven reserves in oil.
Natural gas is either a great investment opportunity or is heading for a train wreck in 2010. Not sure who is right? Then go for these oily names.
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