The Best Natural Gas Stock for 2011 (CHK, APC, DVN, EOG, HK, SD, UNG)

The acquisition of XTO Energy by Exxon Mobil Corp. (NYSE: XOM) instantly turned the oil giant into the largest natural gas producer in the US. We’ve already had our say about Exxon’s prospects for 2011, so we’ll leave it out of this story, and we’ll also leave out BP plc (NYSE: BP), another large gas producer. Instead we’ll look at five companies closely associated with the natural gas: Chesapeake Energy Corp. (NYSE: CHK), Anadarko Petroleum Corp. (NYSE: APC), Devon Energy Corp. (NYSE: DVN), EOG Resources, Inc. (NYSE: EOG), Petrohawk Energy Corp. (NYSE: HK), and SandRidge Energy, Inc. (NYSE: SD).

Many investors have tried and tried to make their natural gas bet on the ETF-ETN tracking natural gas via the United States Natural Gas (NYSE: UNG).  That has actually worked of late, although this exchange-traded product has long suffered from rolling issues and price erosion followed by mistrust from many investors.  Still, it trades over 20 million shares a day.

The problem facing all natural gas producers is low gas prices. According to the US Energy Information Administration, natural gas spot prices at Henry Hub have fallen from $5.83/thousand cubic feet in January 2010 to $3.71/thousand cubic feet at the end of November. Prices are up since then, closing yesterday at $4.17/thousand cubic feet, due mostly to colder weather.

Low prices are a function of booming production from US shale gas fields like the Haynesville, Barnett, and Eagle Ford. Shale gas fields reach peak production very quickly and spit out high daily volumes of gas. Producers have been forced to drill more wells because they are bound by lease agreements that would require them to give up their leased land if they do not develop the lease. The companies drill to maintain their leases, keeping a tight lid on the price of gas. As a result, gas prices are not expected to improve much above $5/thousand cubic feet in 2011.

Here’s a short table showing the tickers, the current price, the mean target price from Thomson Reuters, the implied upside to that target, and the 52-week trading range.  We’ll add some color after the chart.

Chesapeake holds leases to more land in the Barnett and Haynesville plays than any other company. The company’s problem is that gas prices are so low that it must rely on its production of natural gas liquids and condensates to earn a profit. For 2011, Chesapeake plans to grow its liquids production by 80%, with a goal of having 30% of its total production coming from oil and liquids by 2015. The company’s stock price is essentially unchanged since the beginning of 2010, mostly due to an uptick in the past few weeks due to colder weather.

Anadarko shares have been hit hard by its 25% non-operating ownership in BP’s Macondo well, which is exploded in April killing 11 workers. The company’s shares have doubled, from a low below $35 to just above $70, indicating that investors are not particularly concerned about the company’s liability for the Gulf spill. Today, the company is rumored to be in the sights of BHP Billiton plc (NYSE: BHP) as a possible acquisition target at $90/share. The company’s main organic problems are replacing reserves and producing enough liquids to maintain profits until natural gas prices bounce back.

Devon has essentially left the offshore E&P business and now focuses on onshore North America with proceeds from the sales of offshore assets of more than $7.7 billion. The company will spend the bulk of its 2011 capex budget on developing oil and liquids production.

EOG Resources beat most of the other natural gas companies to shifting its revenue base from natural gas to oil. In 2011, the company expects to get just 33% of its revenues from the sale of natural gas, and plans to spend about 80% of its capex budget developing its liquids production.

SandRidge Energy, Inc. (NYSE: SD) has been a difficult stock in 2010 and its diversification attempts have so far only been rewarding for the newer shareholders who could buy at lower prices.  Shares have recovered more than handily from the lows but the stock is still off about 30% from the peak in January 2010 and its share price is now above analyst mean targets.

Petrohawk raised its planned 2011 capex spending by about $400 million in November, but not in order to drill more. The company’s Eagle Ford and Haynesville projects have been hit with cost increases. Like the other gas producers, Petrohawk is counting on liquids production to boost earnings in the coming year.

Our pick for the top stock in 2011 is Petrohawk. The implied upside of nearly 40% in the company’s share price does not seem out of line with the company’s historical stock price performance. Petrohawk’s focus on the Eagle Ford and Haynesville plays should also result in better earnings, even with the higher costs the company will have to pay.

Until natural gas prices improve, every major gas producer will do all it can to produce more of the higher priced liquids associated with gas production. That was the story in 2010, and it will continue at least through 2011.

Paul Ausick