While the stock is not a bargain, his opinions are available for free on the internet as corporate presentations. Yes, the man is talking his own book, which is why one should always be careful of management’s opinion of their business. I have confidence in him to present a thoughtful, albeit potentially biased, outlook on the industry. Let's begin:
Peak is insinuating that the Haynesville field is the key driver of domestic natural gas production over the past 3 years and rig counts are now declining. The three major shale producing fields are showing declines in rigs, which should result in lower production growth in the future. This is a logical progression and his point seems to be that supply is poised to drop. His point about a lot of natural gas rigs really being devoted to liquid natural gas is quite interesting, because it is a more nuanced understanding than an individual such as myself would achieve looking at the sector. The last bullet point about the liquid focus of drilling is further elaborated on in this slide:
This is something I find interesting because it shows how data can be manipulated (broadly applicable too). NGLs can be diverse and some examples are ethane – used in petrochemical feedstocks - and butane – used in a variety of heating elements. While I am no expert, quick Google searches make apparent that gas and natural gas liquids are not fungible. If other investors/media outlets were to not take this extra step of interpretation, then a much differentconclusion would be reached. It could lead to a much more bearish outlook on natural gas prices due to greater perceived supply - ie. solely looking at rig counts or not breaking down gas vs. liquid production growth in shale fields. In reference to the quote at the bottom of the page - I don't know enough about the production profiles of Haynesville versus Eagle Ford, but its possible that year 1 production per rig or people are intentionally focused on wells that will yield more oil and NGLs. Just from the presentation though, it appears that newer shale production coming online isn't going to replace the older fields that seem to be peaking in production. As an interesting side note, this blog recently made a case that NGLs are also being used to inflate the amount of global oil production.The argument that there is a relationship between coal and natural gas pricing is made in the presentation. While Mr. Peak only uses data for a 2-year period, he points out that coal sets a soft floor under natural gas prices:
I’m not sure this constitutes a bullish insight into natural gas pricing. It is an interesting thing to think about though. The end users of both products tend to correlate to the broader economy (steel, chemicals, electricity, and other industrial uses) and so a correlation between the two should be expected. While the conclusion that coal is setting a floor might be correct, pointing to 2 years of data isn’t exactly a smoking gun. I’m not sure this directly translates into an upbeat case for natural gas since it can be interpreted as a broader recovery in the economy which would then drive natural gas pricing. The spread between the two is way too inconsistent and over too short a period of time to mean much as it is presented.Another data point from the presentation is the very recent drop in continental US natural gas production. The presentation quotes Pritchard Capital Research on December 29, 2010 that "yesterday the EIA 914 reported that Lower-48 production in October fell by 0.15 Bcf/d...it was in line with out expectations. Louisiana posted its first production drop since December 2009, as the Haynesville Shale has not started to decline due to the shift of capital to oilier areas. Additionally, the EIS also revised downward the 2010 Lower-48 production by 0.5 Bcf/d as it was overestimating the other states 2010 production by almost 3%." This can be the beginning of a downward trend or an outlier, but I can see how one can interpret this as the beginning of a trend. Pointing to the shift of capital to oilier areas is interesting because Chesapeake and other natural gas producers have been shifting to oilier areas, and they are one of the major natural gas producers in the US. On this point, Peak’s assertion is substantiated on this point. Based on what recent news and economics 101 (shifting of resources to more profitable uses), this data point does seem to offer a convincing bullish signal in natural gas. Even a slight downward shift in natural gas production would discredit the conventional wisdom that the US is so awash in natural gas that production growth is going to keep at a rapid rate. It is undeniable that there is huge reserve potential, but it seems to be getting pushed further out as more focus is put on onshore oil drilling. The one thing that I find misleading is saying that December of 2010 saw the first decline in production since December 2009. Maybe I am being overly simplistic in asking "holiday vacation? but judging from the identical month seeing a production slowdown, there is probably a relation.
What is interesting is that this presentation focuses on fields that are have increased production through shale gas drilling. The Appalachian/Marcellus basin is not mentioned despite being a huge natural gas play for both conventional and shale production as shown in this map along with fields in Michigan and Indiana. This table from the IEA does show that most of the shale gas production is in Texas, Louisiana, Arkansas, Oklahoma, and Kansas which is the location of the fields mentioned by Mr. Peak, although it doesn't include 2010 (clearly not enough time for Appalachia to witness explosive natural gas production, so I am not using that as an excuse to assume a whole lot has happened recently that would void his argument). In my opinion, the elephant in the room with this presentation is the lack of discussion of other natural gas prospects, which is the greatest driver behind the low prices as they are perceived to be bountiful and accessible at this time. At the same time, as long as that potential natural gas stays in the ground, natural gas could see a rise in price in the short term. For this reason it might not be necessary for Contango to address this issue.
I found this presentation intriguing because it goes against the conventional wisdom about short-term natural gas prices. Exxon’s purchase of XTO is definitely a long-term bullish signal for the industry, but I don't consider this to be very contrarian other than in timing. It will be interesting to see where natural gas prices go from here, because it can have implications for Global Power Equipment Group, an earlier write-up on this website.
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