Natty and UPL

Peter Brandt touched off a conversation with his “Generational Bottom” post this morning on natural gas.  So, what is the financial instrument to play it?

  1. UNG?  With the negative roll, I’ve never seen a crappier product.
  2. Futures?  Premiums over today’s price get large next winter and bigger further out the strip.
  3. Equities?  Let’s consider Ultra Petroleum.

UPL is among the lowest cost producers, with a ginormous asset base, and in spite of their name they are a gasser.  The depressed gas prices led UPL to slash capex for 2012 so production will only grow slightly.  Give them a decent gas price and they will drill their brains out.  Gas at $6 gets them 100% internal rates of return in the Pinedale and Marcellus.

UPL’s market cap is $3.3 billion.  Given them a $5 gas price and their proved PV-10 is $8.9 billion.  With $6 gas P3 PV-10 balloons to $18.7 billion.  Hedges are supporting realized cash flow:  $5.05 gas got them $1.03 billion in 2011 EBITDA and $4.00 gas would get them $840 million in 2012 EBITDA.  Remember, UPL is a growth story in a ‘normalized’ pricing environment.

As for the generational bottom, I am believer.  The $1.90 was the tail end of a bear market driven by the shale gas land grab, punctuated by a really warm winter.  Electricity generation switching will take care of most of the current storage glut this summer.  As for natural gas over-production, supply is down 5 bcfd since November and headed lower based on the gas rig count.

But do not color me bullish.  Natty production is still in over supply and production needs to fall further.  The coal switching will end at $3 and $4 gas.  Gas production associated with booming oil production will continue.  And a host of producers like UPL will be chomping at the drill-bit to ramp production again.  That’s what gassers do.