Maybe the worst question an investor can ask about a stock or sector is "how much worse can it get?," as the answer is often something along the lines of "a lot." That seems like a relevant point when considering Ultra Petroleum (NYSE:UPL) - a natural gas-focused exploration and production (E&P) company that has long been a top-notch operator, but has suffered from rock-bottom gas prices. It's probably true that higher natural gas prices are inevitable as export-oriented liquefaction facilities come online and more energy consumption is shifted to gas, but that's a multi-year process that still leaves ample room for volatility in these shares.

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Second Quarter Data Positive ... to a Point
Ultra Petroleum did better than expected in its fiscal second quarter, but it's not as though that will dramatically help sentiment.

Production improved 10% from last year, but shrank about 5% on a sequential basis. Ultra's production continues to be overwhelmingly gas-oriented and oil production didn't improve significantly on a sequential basis (it actually declined slightly). Realized prices were slightly better on a sequential basis, but down 22% from last year.

Ultra's production costs continue to be fairly respectable. Per-unit cash operating costs dropped about 7% sequentially and 12% from last year, though DD&A costs did rise both sequentially and annually.

SEE: A Guide To Investing In Oil Markets

Trading off Production for Returns
One of the talking points on Ultra for some time now has been the extent to which operating partners Royal Dutch Shell (NYSE:RDS.A, RDS.B) and Anadarko (NYSE:APC) will compromise Ultra's historical cost and return leadership.

Shell has been testing cheaper well options in the Marcellus, including using a smaller number of frac stages and lower fluid volumes, and that seems to be working pretty well. Nevertheless, both Shell and Anadarko have substantially cut back their drilling plans, with Shell now targeting half as many wells as originally forecasted. This is a consummate mixed blessing for Ultra, though. Yes, it's good to not fritter away the company's assets at such low prices, but drilling curtailments today mean less production growth next year.

How Will the Niobrara Go?
Ultra's best near-term prospect for oil and liquids production is in an acreage in the Niobrara, where the company is doing some early-stage work. While this is a promising area, thus far the Niobrara has been notoriously inconsistent and investors ought to temper their optimism with a little caution. Companies like Whiting (NYSE:WLL) and Devon (NYSE:DVN) have done alright there, but other companies like Apache (NYSE:APA) and Chesapeake (NYSE:CHK) have looked to sell some of their interests there.

SEE: Oil And Gas Industry Primer

The Bottom Line
I don't see that there's a huge amount of remaining coal-to-gas switchover capacity in the utility industry, and developments like expanded LNG exports and gas-fired generation are going to take years to bring on line. In other words, the long-term picture for higher natural gas prices is encouraging, but the near-term is just a guess - a cold winter would help, but inventories and production levels are still quite high.

Ultra Petroleum still seems too cheap on its long-term potential, but that potential could take quite some time to develop. If you look at Ultra's likely near-term EBITDA or cash flow the stock does not look all that cheap, but the picture changes with longer-term NAV/PV-10 types of analysis. This stock could work pretty well as a long-term holding, but potential buyers have to be willing to take on some near-term risk and the potential of dead money as natural gas prices work through this rut.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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