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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.

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