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Playing with Natural Gas



March 16, 2012 – Comments (0) | RELATED TICKERS: XCO , SD.DL

Board: Value Hounds

Author: hockeypop

Comments and critique are welcome.

Hi Hockeypop,

Far be it from me to question Wilber Ross investments but I'll throw out a few comments anyway. Since you didn't mention when you thought ng prices may turn around I'm going to assume your intention isn't to bet it will occur this year. If this is correct then IMO there are a heck of a lot of companies that can give you plenty exposure to ng that likely don't carry the short term risk that this company appears to have. (OK, to be precise appears to me after all of a 2 minute look at a company that I don't follow.)

Glancing at their presentation here is what jumped out at me at me.

1. Most of their production is coming from the Haynesville/Bossier which without knowing anything about the company tells me they produce a lot of dry gas with very expensive wells. While I am sure like all companies they likely show low costs, one needs to be certain their definition and yours are the same i.e. are their claims all in costs or a definition that is a bit more flexible?

If you go look at the fall off in rig counts you will see that the biggest drop off has come in the Haynesville/Bossier so the question IMO becomes why. While some of that may be attributable to previous high rates of drilling due to HBP issues I doubt that is the only reason and if it isn't I would think that investing in a play that was a near universal pick (based on the rig ct drop) by producers when they wanted to back away from ng would not be the area to recover the quickest if things get a bit better.

2. I spent about a minute looking at their production and hedges so this isn't exactly investment advice. :<) They look to produce about 70% of their BOEs from NG with 30% from Oil & NGLs. (Not sure of the mix between oil & ngls) So just a WAG on my part would be that if you look at it from a revenue perspective not including the impact of hedges they likely are currently deriving 70% of their revenue from Oil and 30 from ng. They have hedged 45% of production spread equally on oil & ng and only have hedges for 2012 on both oil & ng.

So now lets think about what will happen if ng doesn't recover in 2012. Well that is easy, they are set to exchange the 45% of ng production they are currently receiving $5.27 for whatever the spot price is or perhaps a somewhat improved price from replacement hedges that are still most likely to be well below their current $5.27 price.

Do you want an even scarier scenario? Try plugging in some assumptions about what will happen if the price of oil declines. Again I haven't really looked but if my assumptions are roughly correct about revenue contributions from oil then any decline in oil prices will have a lot more pronounced impact on revenue/profits (from the 55% of unhedged oil)than any change in ng prices is likely to have and there is a distinct possibility that both could occur. (No material ng recovery and a decline in oil prices)

So at a glance it appears to me that while you may be viewing this as a play on ng in reality most of your downside exposure is linked to the price of oil.

As an example of a company who has a lot of exposure to a recovery in ng without the issues I see with XCO I'll use SD. SD currently produces roughly 50% of the BOEs from oil with 50% from ng with oil approaching 90% of the contribution on a revenue basis. What is different about SD is they are completely unhedged with regards to NG (Thus will have the upside if prices were to recover)and currently have approximately 85% of their oil production hedged. Now there may be other reasons (iffy balance sheet & no dividend) that may preclude SD as an investment in your mind but if you look at SD under the various what if price scenarios with regards to oil & ng prices in the next two years it is hard for me to see how someone like SD isn't a safer investment while waiting on ng prices to turn.

Final thought; Do you really think a 2.3% divi will be material vs. any impact changes in oil & ng prices are likely to have on this investment? Cash IMO is a safe investment as well and if you can't pick up 2.3% waiting a year for that fat pitch in the energy sector you probably aren't paying attention. :<)

Good luck with whatever you decide,


PS Although I am long SD I currently have the smallest position since I've owned them, my use of SD was really only for an example of the point I was trying to make. My largest & favorite investment today is cash. :<)

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