Natural Gas Pipe Dreams to Avoid

This week, Nabors Industries ( NBR) joined the list of gas drillers looking for more and more exposure into pressure pumping, also known as hydraulic-fracturing.

The sector has become literally overheated with industry stalwarts convinced of the inevitability of natural gas growth, natural gas prices and shale. We've seen multi-billion-dollar deals from drilling majors Schlumberger ( SLB) and Baker Hughes ( BHI) last year, followed by similar smaller deals from Patterson-UTI ( PTEN)and now Nabors.
Natural Gas

I'm a big believer in the inevitability of natural gas from shale, but I make money from finding and betting on stocks, not from pipedreams of our energy future. I see the sector as far too crowded right now, in light of current gas prices and drilling headwinds. There'll be far more opportune prices to find value in shale plays, and this deal convinces me that now is the time to be on the sidelines.

Oil Stocks to Avoid

Nabors was a recommendation I made several weeks ago, precisely because of its singular, land-based drilling exposure. I had been leery of involvement in off-shore names, considering the blown well in the Gulf of Mexico and tried to find a driller with concentrated assets in traditional land operations.

Nabors shares had been closely aligned with the price of natural gas and made for a great derivative play on what I thought was a price that could do nothing but go up. But the recent buy of Superior Well Services ( SWSI) has changed my view on the stock. The all-cash $900 million deal will force Nabors to sell lucrative Columbia assets to finance, while focusing them much more exclusively on shale plays that require the pressure pumping ability that Superior Well Services will bring.

Never mind that Nabors spent an estimated 10.5 times EBITDA for the company, significantly more than Patterson-UTI did for their buy of similar pressure pumping services from Key Energy ( KEG).

Also ignore that Nabors will probably need a secondary stock offering to pay for the deal. Because of this deal, Nabors is now entering a very crowded space of players relying upon the quick growth in shale gas production from the Haynesville, Barnett and particularly the environmentally-charged Marcellus.

It's just too tough a space to succeed right now. Other, larger and better connected drilling companies have already made their bets in that space and have a huge leg up on the business there, particularly heavyweights Schlumberger with its 2009 buy of Smith international ( SII) and Baker Hughes with its purchase of BJ services.

And the rush into this space is not being supported, either by Washington, or by the price of natural gas right now or on the forward curve of prices.

We all are aware of the controversy surrounding hydraulic fracturing technology . Industry experts believe that groundwater contamination is entirely avoidable, while environmental groups dispute all of the safety claims. It seems clear that the environmentalists, at least right now, have the ear of the Obama White House, as can be seen by the very tepid embrace of natural gas in the current energy bill.

And the prices of natural gas are not supporting the growth in shale gas, either. Not only have prompt prices for gas decreased recently from over $5 to just over $4.30 in the spot month, but the curve of prices -- the representation of prices for monthly deliveries in the futures markets -- has been getting significantly flatter since early May.

What this is saying, in essence, is that those betting on gas prices believe that oversupply will essentially remain and even moderate growth in energy demand will be easily met with existing supply. The futures price for natural gas in January 2011 is right now still trading under $5, about 65 cents more than prompt gas.

Everything is pointing to a very challenging environment for shale gas plays. While I think the inevitability of shale is impossible to deny, I now believe that this is the wrong time to invest. It's a pipedream right now, and through that pipe flows shale gas from the Marcellus, where so many big players have laid down their bets. I think that money is going to stay on the table for a while, untouched, and I'm looking for other places to put my bets.
At the time of publication, Dicker was long Baker Hughes.

Dan Dicker has been a floor trader at the New York Mercantile Exchange with more than 20 years' experience. He is a licensed commodities trade adviser. Dan's recognized energy market expertise includes active trading in crude oil, natural gas, unleaded gasoline and heating oil futures contracts; fundamental analysis including supply and demand statistics (DOE, EIA), CFTC trade reportage, volume and open interest; technical analysis including trend analysis, stochastics, Bollinger Bands, Elliot Wave theory, bar and tick charting and Japanese candlesticks; and trading expertise in outright, intermarket and intramarket spreads and cracks.

Dan also designed and supervised the introduction of the new Nymex PJM electricity futures contract, launched in April 2003, which cleared more than 600,000 contracts last year alone. Its launch has been the basis of Nymex's resurgence in the clearing of power market contracts over the last three years.

Dan Dicker has appeared as an energy analyst since 2002 with all the major financial news networks. He has lent his expertise in hundreds of live radio and television broadcasts as an analyst of the oil markets on CNBC, Bloomberg US and UK and CNNfn. Dan is the author of many energy articles published in Nymex and other trade journals.

Dan obtained a bachelor of arts degree from the State University of New York at Stony Brook in 1982.

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