Getting Into Natural-Gas Stocks
CRT Capital likes large-cap names including XTO and Chesapeake.


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CRT Capital Group

WE LIKE THE GAS NAMES here. Gas prices are likely to strengthen into winter, leveraging the ongoing reallocation of sector effort from lower to higher returns projects.

Here's a mouthful of support: Given the logic and history of higher gas prices in winter, merely normal volumes in current gas storage inventories, and gas prices disincenting liquid natural-gas (LNG) imports…plus recent sector tactics diversifying gas focused players away from funding exclusively gas projects, and the rational behavior of gas producers to reallocate efforts to defer less profitable projects as new out-year focus, we expect ongoing gas prices to support appealing upsides versus current sector values.

Preautumn is arguably the best time to buy the sector each year, as December gas prices have been higher than the prior August in each of the past five years, whether oil prices were up or down during that period. This trend being fairly well known, it pays not to jump in too late, in our view, suggesting now as an appealing time to buy into the sector.

Valuewise, gas producers now have much larger and more visible long-term project upsides than in prior years, having ground-tested multistage fracture completions in horizontal wells for shale reservoirs.

Our targets, using $9.25 per million British thermal units and $90-per-barrel oil for full-year 2008, support very appealing one-year upsides. We favor large-cap XTO Energy (ticker XTO) ($68 price target), Chesapeake Energy (CHK) ($64 target), and EOG Resources (EOG) ($131 target), in that order, and less obvious and smaller Forest Oil (FST) ($83 target) and Plains Exploration & Production (PXP) ($89 target), all Buy rated.

We see an unlikely collapse of oil prices to below $90 per barrel before year end as a risk to our call. Prospects for rapid gas-production growth this year and beyond have spooked investors. Coincident with imminent shoulder-season gas-demand weakness (due to waning air-conditioner loads and still too early for heating loads), current share price entry points for gas-levered names look to have both appealing long-term upside, and utility for a seasonal trade into likely stronger winter markets.

Despite investor concern over production growth from new areas, gas storage remains near average, partly the result of very low LNG imports, and producers are unlikely to exacerbate price weakness by overdrilling in the lowest priced markets, like the Rockies, for example.

We see the emergence of new shale-gas prospects as promoting reallocation of capital and effort to other project areas as a more likely scenario than one where producers create a train wreck of oversupply.

For example, companies with both Rockies (lower-priced gas and less-prolific wells) and

Haynesville Shale [Louisiana] (higher-priced gas and more prolific) are more likely to shift efforts to the Haynesville than to go full speed ahead in all areas, in our view. And companies with little diversification are likely to seek more of it, including adding oil-project exposure.

-- Duane Grubert
-- Gray Peckham


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