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Oil has spiked recently at $107 a barrel, but I the more interesting story lies in recent developments in natural gas, which might be becoming a more viable alternative to oil.
In particular, the DOE predicts an increase in U.S. natural gas consumption in 2008 of 0.9% and a jump of 1% in 2009; while lower than the 6% growth in 2007, these increases are a reversal of recent consumption trends as can be seen in the following graph. Of course, global warming might throw a wrench into these predictions, but this phenomenon, as I understand it, is associated with not only warmer temperatures but also more volatile temperature changes.
In that context, I'll be looking at oil companies with a significant and growing natural gas presence. One such company is EnCana (ECA - commentary - Cramer's Take), the largest integrated oil producer in Canada. Earnings for this company in 2007 declined by 16.7%, primarily due to the company realizing mark-to-market losses on financial hedges; without these losses, earnings would have increased by 9.2%. EnCana boasts a market cap of $57.7 billion, but what distinguishes it from its two other rivals -- Canadian Natural Resources (CNQ) and smaller Petro-Canada (PCZ - commentary - Cramer's Take), with market caps, respectively of $40 billion and $23 billion -- is the size of the EnCana's natural gas production and proven reserves. With its natural gas resource plays, EnCana increased natural gas production by 14% last year, while CNQ's and PCZ's natural gas production fell, respectively by 1.8% and 2%, respectively. EnCana is also prospering in its integrated oil business; it announced last year the creation of a joint venture with ConocoPhillips (COP - commentary - Cramer's Take) to create an integrated upstream and downstream North American venture in heavy oil production. The Canadian company will bring to the table its upstream assets in the Albertan oil sands while the U.S. company brings its downstream assets into the venture.
Compared to PCZ, for instance, EnCana reported much higher stock returns. The two-year returns for PCZ and ECA were 7.2% and 47%, respectively; the 52-week returns were 44% and 74%, respectively.
While this makes EnCana slightly pricier than PCZ, with P/E-to-growth ratios of 1.33 and 0.74, respectively, I'll take my chances that EnCana's natural gas play will bring it on top for 2008.
It should be noted that natural gas prices as reported on Nymex declined by 5% last year; the outlook on natural gas prices next year notwithstanding, EnCana's realized gas prices increased by 7% over the same period due to its natural gas hedging activities. The company reported that it is continuing in this vein, since it is hedging 1.9 billion cubic feet of gas per day between January and October 2008 at a price of $8.21/Mcf. The DOE is expecting an average price of gas next year of $7.83/Mcf, increasing slightly to $7.93/Mcf in 2009, so EnCana's short hedge should prove to stabilize its earnings at least through 2008.
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At the time of publication, Vijayraghavan was long EnCana. Vasu Vijayraghavan was an academic finance professor at the University of Paris who has now turned to a new career as a financial consultant. As an academic, she wrote on corporate governance issues, especially in the European context, and she believes in a long-run and balance sheet approach to stock picking. Currently, Vijayraghavan is working as a consultant for lawyers, doing business valuation. She is a Level II CFA candidate and enjoys writing long/short and earnings calls pieces for TheStreet.Com. Vijayraghavan holds a Ph.D. from the University of Michigan and a B.A. from Harvard University.
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