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Stock Strategist

Natural-Gas Producers Are on Sale

Here's our bullish case for natural-gas stocks.

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For the second straight year, we have seen natural-gas producers' stocks sell off over the course of the summer as natural-gas storage levels reach record highs. Mild weather, which has limited heating and cooling demand over the past two years, is the root of the problem. As a result, natural-gas spot prices have recently been hovering around $5 per mcf (thousand cubic feet). We think that this is a pretty low level given strong domestic demand, the declining nature of natural-gas wells, and the cost to find new reserves. In our opinion, natural-gas prices will have to average more than $7 per mcf over the next five years to encourage investment in new supply.

Natural-gas prices of $5 per mcf put tremendous strain on some domestic producers, especially those with significant Rockies operations. Currently, a lack of pipeline infrastructure is causing natural gas in the region to sell at a steep discount to Henry Hub, the industry benchmark. Natural gas in the Rockies has been selling at less than $4 per mcf for most of the summer, and in recent weeks has occasionally dropped below $0.50 per mcf. There's a strong possibility that some high-cost regional producers could be in the red for the third quarter if they are not significantly hedged.

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Justin Perucki does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.