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Steep drop in crude prices poses challenge to natural gas industry

on January 28, 2016 12:31 AM

STATE COLLEGE — Investors are finding value in slumped natural gas stocks as crude oil prices hit new lows in 2016.

Precipitous changes in the price of crude oil and slower growth in China have been two catalysts for the U.S. stock market's turbulence, which sparked fear of nearing bear market territory among many market watchers.

While oil prices did rally Jan. 26 with news the day before that OPEC might be ready to negotiate over supply with non-OPEC producers, oil prices this month have reached levels last seen in 2004.

Prices react to the news,” said Barry Ickes, a professor of economics at Penn State. “If developments change, expectation prices react, but fundamentals are driving the price.”

The price for West Texas Intermediate crude was up 57 cents to $30.51 a barrel on the New York Mercantile Exchange at the end of the trading day Jan. 26, and international benchmark Brent crude was up to $31.14.

While prices rose as much as 6 percent at one point on Jan. 26 with Brent and U.S. crude both briefly above $32 a barrel, the Associated Press reported that oil prices are still down nearly 18 percent this year, hitting 12-year lows at less than $28 a barrel earlier this month.

It is crucial that all major producers sit down to come up with a solution to this,” said Abdalla El-Badri, OPEC’s secretary general, in a speech he gave Jan. 25. “The market needs to see inventories come down to levels that allow prices to recover and investments to return.”

Volatile oil prices depend on expectation, Ickes said. There is some skepticism about OPEC’s promise to tackle what has amounted to an 18-month oil glut, especially without Saudi Arabia and its OPEC allies committed to negotiations.

Another OPEC producer, Iraq, plans on boosting supply after its government reported its oil output reached a record high in December. Iran is planning on resuming exporting with its lifted sanctions.

(Saudi Arabia) is pumping as much as they can to bring the price down so that the fracking industry doesn’t flourish,” said Fariborz Ghadar, a professor of finance in Penn State’s Smeal College of Business. “It’s sort of a ‘I hurt myself a little, but it hurts you a lot more.’”

For natural gas companies, more supply than demand has meant prices have dropped. The price of natural gas at the benchmark Henry Hub has declined from about $6 per million Btu in January 2014 to about $2 per million Btu in December 2015.

Oil prices have declined substantially, so there is less interest in substituting cheap natural gas for oil,” said Dennis Sheehan, a professor of finance at Penn State.

Indexes for two State College-based energy companies have taken hits amid this downturn. Eclipse Resources Corporation (NYSE:ECR) and Rex Energy Corporation (NASDAQ:REXX) are both independent oil and natural gas exploration and production companies operating in the Appalachian Basin. Rex Energy also operates in the Illinois Basin.

Rex Energy’s third-quarter production was 15 percent more than it was in the same quarter in 2014, but its net income loss per share was -0.26. As of Jan. 26, the share price dropped about -88 percent from its $5.71 peak in May 2015.

Cost containment and operational efficiencies are positioning us to weather the low commodity price environment,” said Tom Stabley, Rex Energy's president and CEO, in a press release.

However, both firms are also highly leveraged, Sheehan said. Due to the decline in market cap, with both firms losing about 95 percent of their stock market value in the last two years, debt capital for Eclipse is about 70 percent, while it is 95 percent for Rex Energy, Sheehan added.

While spot prices for the benchmark Henry Hub have reached a 17-year low and natural gas production has reached record levels, with an average 76.6 billion cubic feet produced per day in 2015, the U.S. Energy Information Administration’s Short-Term Energy Outlook forecasts Henry Hub to average at $2.65 per MMBtu in 2016 and $3.22 per MMBtu in 2017.

Market analysts are saying that natural gas companies are better equipped to handle downturn after facing low prices in recent years and that the upturn in prices could make them likely to perform better. Analysts are also predicting that crude oil prices are likely to remain in the $30 to $40 range for at least the next year, Ghadar said.

Investors have to realize this is the type of investment they’ve made, and if they don’t like the volatility they shouldn’t be in the sector,” Ghadar added.

Rex Energy and Eclipse Energy are expected to release fourth quarter statements in February and March. respectively. Eclipse Energy declined to comment for the story and Rex Energy did not respond to requests by press time.

 

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