“…EQT is up a whopping 610% over the last 20 years, S&P is up 231%. I’m sorry, that’s truly incredible out-performance which is why I keep featuring these stocks.

EQT is one of the lowest cost producers of natural gas out there. With total production costs of $2.30 per thousand cubic feet, an average finding development cost of just $1.14 per 1,000 cubic feet over the last years…They can sell it for four times of that… EQT is also growing its production, up 19.5% year over year for the fourth quarter. 20% production growth for 2010. It’s a growth stock. Much of the growth comes from the shale in Appalachia where EQT is drilling like crazy.

The company plans to have 40 to 50 new wells in the Marcellus shale in 2010 and expects production to double for the year. This stuff is incredible. Thanks to the Marcellus that EQT’s proven reserves hit 4.1 trillion feet at the end of 2009, up 31%. The company also has a total of 26 trillion cubic feet of potential resources…” –CNBC’s Mad Money 2/1/2010

Cramer has crusaded on the behalf of natural gas a lot recently believing that domestic natural gas production could go a long way towards solving some of the difficult energy problems we face.  He is a proponent of using natural gas as a bridge fuel to transition the U.S. economy away from crude oil and coal towards greener alternatives which are not able to carry the load yet.  On Monday evening, he has brought forth yet another stock that he thinks could have huge upside when he interviewed Murray Gerber, CEO of EQT Corp. (EQT), formerly known as Equitable Resources.

He points to EQT’s solid out-performance of the broad market over both short and long term time frames, and the fact that production is growing at a very rapid rate as reasons to excite investors.  Furthermore, the company has successfully grown production while keeping costs low, which is a positive reflection on management.  Last week, the firm delivered an impressive earnings beat, earning 52 cents per share versus analysts’ estimates of 39 cents.  The market has started to take notice of this performance and the earnings report last week provided a catalyst to boost the stock about 7%.  Cramer, who is never shy about making a bold statement, said he wouldn’t be surprised to see this stock triple.

At Ockham, we cannot share the same optimism for EQT Corp. because our methodology already shows the stock is Overvalued.  We downgraded the company coming into this week, as it is currently trading above its historically normal valuation ranges.  For example, price-to-cash earnings is currently 18.3x, which is well above this company’s historical range of 9.5x to 17.1x.  Similarly, price-to-sales normally ranges between 2.3x and 4.1x, but at the current price level yields 4.7x revenue per share.  Cramer would argue that EQT’s growth accounts for the significant premium that the shares are being given, but current estimates show revenue declining slightly in fiscal 2010 (then a large bump up in 2011).

We share Cramer’s aspirations for increased usage of domestic natural gas, but it will take quite a bit of effort and some of that would surely be directed from Washington.  Right now it does not appear to be near the top of the political agenda, and may not be until something knocks us out of our comfort zone (geopolitical threat, spike in oil prices, etc).  At this point, we would advise waiting for a dip in EQT before it becomes an attractive stock for value investors.

“Look at one of our key export companies, Ultra Petroleum. This one a bit of a laggard lately, up only 15% since we had on the CEO…Companies like Exxon recently validated our vision on this show. Second, the company has a average working interest of 50% in Wyoming’s Pinedale Anticline, which despite of drilling delays and higher costs is moving forward.” — CNBC’s Mad Money 1/14/2010

Jim Cramer is nothing if not persistent and over the last few months he has constantly recommended stocks in the natural gas space.  His natural gas investment thesis has seemed to be justified with recent price appreciation in many of these companies and additionally some huge M&A activity from the likes of Exxon Mobil (XOM).  Cramer invited the CEO of Ultra Petroleum (UPL) onto his show in order to explain why the stock has lagged its competitors and how that will change soon.

Cramer expressed optimism for Ultra Petroleum’s new acquisition of a substantial amount of land in the gas-rich Marcellus Shale, and that purchase has yet to be reflected in the stock’s price.  XTO was a major player in the Marcellus Shale and obviously that was a key factor in Exxon’s decision to acquire them.  In addition to their growing exposure to Marcellus, they were able to increase production by 27% in the third quarter.  That sort of production increase made Cramer exclaim, “That makes it a growth stock with fabulous margins.”

The biggest problem with Ultra Petroleum is the current valuation, as the company receives our Fairly Valued rating despite its lack of appreciation recently.  As Cramer mentioned, UPL has been a high-flier over the past 5 years and 10 year time periods, although our price data shows far lower returns than he claimed on his show.  Still the numbers are heady, as UPL has grown 3400% in the last ten years (Cramer said more than 14000%). 

As we see it, the stock is still attempting to justify its former growth premium as a more mature company.  Normally when a stock has been valued so richly by the market in the past, its current valuation tends to look undervalued when compared to historical valuation multiples such as price-to-sales and price-to-cash earnings.  It is just the opposite for UPL and it is actually approaching overvalued territory based on our methodology.  We will need to see further improvement to fundamentals like sales and cash earnings before we start to look more favorably on this company.  Perhaps the new acreage in the Marcellus Shale will provide the fundamental growth that we need to see, but for now there are more attractive natural gas stocks.

"Exxon-Mobil and XTO Energy. Exxon is buying XTO for $41 billion. A natural gas play and all stock deal, Exxon-Mobil the biggest percentage loser in the Dow, down 4%." — Fox Business Network 12/14/2009

On Monday morning, Exxon Mobil (XOM) announced their largest acquisition since Mobil in 1999.  Exxon will pay around $51.69 (.71 shares of XOM) per share of XTO Energy (XTO) as well as assume about $10 billion in debt, in sum the deal will cost about $41 billion.  Although the offered price represents a 25% premium over XTO’s Friday closing price, Exxon is acquiring America’s largest unconventional natural gas producer. (following ratings chart of XTO)

This increased emphasis on natural gas will put further distance between Exxon and other major oil firms in terms of natural gas reserves.  Exxon hopes that natural gas will find favor in Washington and gain wider use as a domestic energy source over coal.  Proven reserves of natural gas in the United States have ballooned in recent years thanks to "shale gas" which is attainable through modern drilling techniques and makes natural gas an extremely abundant domestic resource.  Clearly, Exxon, already a heavy hitter on K-Street, will commit substantial resources towards these goals.

Exxon has a reputation for being one of the most conservative of the oil giants.  Led by CEO Rex Tillerson, Exxon has made a statement with today’s deal that they believe there is a long term trend that will benefit natural gas producers.  They obviously see a shift in the way natural gas is utilized, as prices have been suppressed for more than a year and a record 3.7 trillion cubic feet in storage proves supply is swamping demand.  However, Tillerson has said that he believes demand for natural gas will outpace both oil and coal in the coming years, based on his belief that natural gas will find more frequent use as a source of electricity generation in the future.  Gas burns cleaner than coal, and if cap and trade legislation passes through Washington a shift may be inevitable. (following ratings chart of XOM)

Exxon is looking towards natural gas for growth, and with the natural gas prices still low they hope to have bought valuable resources for a good price.  According to Bloomberg, this deal will cost Exxon $13.42 per barrel of oil equivalent reserves, which is expensive when compared to recent deals priced at around $10 per barrel of oil equivalent reserves.  But XTO’s assets in the Barnett Shale and other prodigious fields may justify the premium.  As for our methodology, we had an Undervalued stance on XTO as of Friday’s closing price $41.52, and given the current fundamentals the offered price does not seem unreasonable.  Given current revenue and earnings strength, we think any price south of $60 would have been in line with fundamentals.

This is no doubt a bold strategic move for Exxon and it will be very interesting to see if other domestic natural gas producers like Devon (DVN) or Chesapeake (CHK) are next to be targeted in a wave of consolidation.  If Exxon is right and natural gas sees wider adoption for electricity production, this will undoubtedly be a boon to shareholders.  From our view, the price paid is well worth the potential that this deal holds for the long term energy market.

“This whole move is predicated upon the idea that Washington has at least embraced natural gas, that this cleaner, greener fossil fuel — I know it’s fossil, which puts it in the dog house — will be a part of our energy future. Take Anadarko, Anadarko Petroleum is one of the strongest derivative natural gas plays, one of those I’ve been recommending since January 12th, when it was at $38.33. The stock is now up to $54.40. A 40% increase. Even as the price of the commodity has just been crushed.

If natural gas is going to be part of our energy future, then Anadarko is a fantastic stock to own. And its second quarter, recorded record sales volume, selling 4 million more gallons than the midpoint of Anadarko’s guidance. As well as record drilling, the company was able to run fewer rigs but drill more wells and the cost of wells coming down. Anadarko’s a great growth energy with new discoveries in the Gulf of Mexico and Mississippi, a major new project in Ghana that was approved by their government in July and another project in Algeria that’s expected to start producing oil in 2011.

The company’s also done a great job of hedging its natural gas 80% of anticipated natural gas volumes, hedged at $4.18 in the summer months. Hey, who would ever thought that was going to be good, right? And more than 75% of its 2010 natural gas volume’s protected with a middle floor of $5.60 and an upper ceiling of $8.25. So, even if natural gas prices don’t bounce back hard, Anadarko’s still in good shape.

And it’s not starving for cash, either. Remember it raised $1.3 billion with that secondary offering in May? That was at $45.50. Made a lot of people money. You’re up 20% if you got that offering price. Even, again, natural gas collapsed and they raised another $109 million in debt in June, leaving them with $3.5 billion in cash at the end of the quarter and no debt coming due until 2011.” — CNBC’s Mad Money 8/24/2009

Cramer invited Jim Hackett CEO of Anadarko Petroleum (APC) onto his show to discuss the natural gas industry.  As you can tell from Cramer’s lead-in to the interview, he is very high on Anadarko specifically and has been recommending them since January.  More generally, he is very interested in discussing the benefits of shifting America’s energy infrastructure to run on natural gas that has been produced here in America instead of continuing to import crude oil from all over the world.  He made a compelling case for natural gas being a step in the direction of energy independence, and we can hope that this kind of thinking makes its way to Capital Hill soon.

Looking at Anadarko in particular, we think management is doing an exceptional job of dealing with slumping natural gas prices.  As mentioned, APC had the foresight to hedge 80% of their production at $4.18, which seemed low at the time, but this has turned out to be a wise strategy as prices continued to fall.  In addition to smart hedging, Anadarko management continues to increase production through the downturn.  While other producers are forced to slow down production in hopes that prices will rise in the future, APC’s aggressive strategy makes it one of the best positioned to meet today’s challenges.

Anadarko has appreciated more than 40% year to date, and is currently Fairly Valued by our methodology.  Based on the company’s current EPS and revenue figures, we would expect  APC to trade somewhere between $45 and $62.  With that in mind, our analysis would obviously become more positive on Anadarko if the price of natural gas starts to recover.  This is a very real possibility as the ratio oil to natural gas prices has reached 26.35x, which is the highest it has been since at least 1990.  Prices reflect supply and demand of each commodity, but we would expect a reversion to the mean over time. 

The chart to the right lists each stock that Cramer talked about on Monday’s Mad Money.  Please visit Ockham for a complete recap of Mad Money.

OPEC oil ministers decided for the third meeting in a row to lower the daily oil production quota coming from the 12 member cartel. The 2.2 million barrel per day cut is the largest pledged decline in OPEC history in the face of crude oil prices that have fallen more than 70% from record highs this summer. This brings the cartel’s combined production cuts to about 4.2 million bpd. The obvious goal of member countries is to shrink global supply and thus stem the plunge in oil prices. OPEC, which produces about one-third of the world’s oil supplies, normally moves the market with such announcements, but oil is down about five percent today.

OPEC member countries are losing money hand-over-fist as prices continue their free-fall. Furthermore, there is a substantial supply glut in the system, so much so that crude oil is being stored in tankers at sea because there is no place to deliver the product. Saudi Arabia, the largest oil producer in OPEC, is leading the way by lowering its oil production from 9.7 mbpd to 8.2 mbpd. However, Saudi Arabia does not have the massive financial and political pressures that Iran, Venezuela and non-OPEC member Russia have to contend with. All three of these nations need the barrel price of oil to be well north of $50 in order to sustain state budgets planned when oil prices were climbing.  After oil’s dramatic collapse, these countries are operating in the red and will be greatly tempted to ignore OPEC-established quotas in order to generate desperately-needed cash. It is possible that a sustained drop in oil prices could threaten the stability of the Venezuelan, Iranian, and Russian governments.

According to CNBC, the previous two OPEC production cuts have only met with an estimated 50% compliance. Expect that ratio to continue to fall if oil prices continue to slide and budget shortfalls intensify. So, in essence, although OPEC member countries are all incentivized to pledge production cuts in the hopes of generating a turn-around in prices, each member country has its own circumstances and many of the poorer nations are simply not going to sit on their hands waiting for oil to rebound. OPEC’s chronic failure to enforce its production quotas makes them of dubious value.

One part of the supply chain that we can track fairly accurately are domestic oil companies, many of which are reigning in capital expenditures greatly. The rapid decline in oil prices has made many U.S. oil and natural gas producers scale back on projects, especially the largest and most expensive ventures. Combine collapsing oil prices with difficult credit markets, and there is very little incentive for producers to bring new reserves to market at the present time. Nearly every company has found that certain projects that looked profitable six months ago simply do not make financial sense with oil now between $40-$50 per barrel. The latest round of cut-backs comes from SandRidge Energy (SD) and Equitable Resources (EQT), which are cutting CapEx spending by 50% and 40% respectively. Hess Corp. (HES) has indicated that CapEx will fall by nearly 40% in the coming year. In addition, Devon Energy (DVN) is holding off on setting a budget for 2009 until it officially closes the books on 2008, not a bad move considering recent volatility. 

While it is unclear just how much the supply will contract, it is clear that OPEC would like it to contract as quickly as possible. Global demand has been extremely weak in recent months as a world-wide recession has taken hold. Modern economies run on oil and when economic activity begins to grow again, watch out for a spike in oil prices, as supply will be likely be tight. This will only exacerbate the roller coaster ride in oil prices that we have seen over the past few years.

One word of note, readers of our blog will recall a post from October 16^th (Oil Stocks Are Cheap, But Will It Last?) describing the status of energy stocks as crude prices continued to drop. At the time oil had dropped exactly 50% from the high of $147 just a few months before, and I attempted to speculate as to where the floor in oil prices would be. I made the case that supply would be constrained by a further drop in prices from $74 as expensive production projects would be placed on hold, and that a drop substantially below $60 per barrel is not sustainable.

Well, let me say, that while a price this low may not be sustainable, I did not anticipate the steepness of the drop we have seen. However, my over-arching theory (as an equity analyst, not an energy analyst) was that oil stocks were due to rebound. And rebound they have, of the four stocks highlighted in that piece, only Transocean (RIG) is lower, dropping losing 18% since the post. RIG supplies deep-water drilling equipment and is especially susceptible to the declining price of crude. The big winner has been oil and natural gas producer Petrohawk (HK) which in two months time has gained 72%. Likewise the two major producers Exxon (XOM) and Chevron (CVX) have both gained more than 30% in that time.

So, the fundamental question is when will economic growth recover? According to the NBER, the current recession began a year ago, and it is already the 4^th longest recession in more than 80 years. We have included a helpful chart from the Wall Street Journal for reference.  We firmly believe that this recession is not going to be another Great Depression, as some pundits and politicians would have you believe. The Fed and other central banks around the world have pledge to take all available actions to preclude this type of economic catastrophe.  Yesterday, the Federal Reserve cuts its Fed Funds Target Rate to an historic low, .25%.   While it is anyone’s guess as to how deep this recession will ultimately be, it is likely that the worst is behind us and economic activity could very well begin to grow within the next few quarters.