Paradigm Paradigm Capital analyst Adam Gill thinks the collapse in demand for natural gas is “likely insurmountable for [a] bullish case” for exploration and production companies.
“Given the significant softness in heating demand in the most important month, natural gas prices have fairly fallen,” he said. “That said, we have seen winter weakness followed by stronger springs/summer the past five years in the gas market, but that said we believe a recovery in price this year will be harder to come by given limited growth in new demand and expected production increases. Thus, we are downgrading our outlook on gas equities.
“Residential/commercial demand is the biggest factor over the winter, peaking in January. That said, January demand month-to-date has averaged 38.7 Bcf/d, the lowest since January 2006, and while the outlook is starting to improve for the last week of the month, demand so far is 10 Bcf/d off average levels. While there is still some winter to go, it is unlikely that the demand differential can be made up in in the coming months outside of an extremely cold February, like in 2021. If we have a one-in-five-year heating demand like we saw in 2014 and 2019, the market would be in a better position but not one that would be a clear bullish case, in our view. We are likely entering a period of higher inventories.”
Mr. Gill said the recovery in 2021 and 2022 was driven by increased LNG demand and gas-burn electrical generation capacity, however he thinks those factors are not existent this year. Accordingly, he does not see “the same recovery set-up in gas prices as in prior years.”
“With a warm January and a challenged supply/demand balance, gas prices have cooled off substantially over the past 1.5 months, with the 2023 NYMEX strip down 37 per cent since the start of December while the AECO strip is down 30 per cent,” the analyst said. “That said, the equities have held in much better, driving a re-rate on valuation. From the start of December to today, the Canadian gas-weighted E&P average valuation multiple has increased 0.8 points, the liquids-rich group has seen a 0.6-point increase in valuation multiple while the oil names have been steady in valuation. The same impact has been seen on FCF yields. Thus, we would angle exposure in the energy space to the oil-focused E&Ps at this juncture until we see a turnaround in the gas macro.”
Mr. Gill downgraded his ratings for his “drier” gas producers, moving Birchcliff Energy Ltd. and Pine Cliff Energy Ltd. to “buy” from “hold” with targets of $9.50 and $1.60, respectively, down from $12.25 and $2. The averages on the Street are $13.41 and $2.01.
He also made these other target reductions:
- Advantage Energy Ltd. ( “buy”) to $11.85 from $14.25. Average: $14.11.
- ARC Resources Ltd. ( “buy”) to $23 from $24.50. Average: $24.70.
- Kelt Exploration Ltd. ( “buy”) to $6.25 from $8.50. Average: $8.98.
- Spartan Delta Corp. ( “buy”) to $19 from $19.50. Average: $21
“We continue to have BUY ratings on ARX, KEL and SDE given the better liquids exposure, and continue to see AAV as the more attractive option on the gas side given the potential in Entropy is current a free option in the stock, in our view. That said, with gas prices pulling back, we current see ARX as our top investment idea in the gas space given valuation and FCF yield,” he concluded.