Natural Gas Prices Are Tanking - Advantage Energy May Suffer - Seeking Alpha

Natural Gas Prices Are Tanking - Advantage Energy May Suffer | Seeking Alpha

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Natural gas prices have fallen sharply since peaking at over $10 a gigajoule in September 2022, reaching just over $1.60 a gigajoule at Henry Hub today. Leveraged producers feel the pain.

Key industry players seem to be looking past the current slump as they merge and acquire to expand their footprint and look to liquified natural gas (LNG) exports as an outlet for low-cost North American gas in demand in gas-starved Europe and Asia. Chesapeake ( CHK) acquired Southwestern to become the largest natural gas producer in January following Exxon's ( XOM) acquisition of Pioneer last October, only to see

Diamondback (FANG) purchase Endeavour in the past few days. The industry consolidation targets not only natural gas but also the prolific shale-based oil production in the Permian Basin, but natural gas is a key part of the economics of each of these deals.

Chesapeake today announced a long-term LNG deal with Delfin and Guvnor targeting Asian markets to realize the Japan-Korea Marker Benchmark (JKM) pricing which is substantially higher than U.S. market prices. JKM prices are about $9 a gigajoule today, but were in the $15 a gigajoule area last year. Netbacks from LNG exports are far more profitable than selling natural gas in the domestic market. The LNG opportunity is a tailwind for U.S. producers that may encourage investors to look past the slump in prices today.

Canadian producers have limited access to LNG markets with the first Canadian LNG terminal still under construction in Kitimat, B.C., and expected to begin shipping late this year or early 2025. As a result, it is the Canadian producers who bear the brunt of the soft pricing that the industry faces today.

Over time, growth in LNG exports should manifest itself in tight domestic markets and all North American producers should benefit. A cold winter in 2024-2025 would be welcome, and seems likely as the current El Nino contributing to the warm winter we are experiencing reverses to La Nina portending a colder winter beginning in late 2024. But for now, it is Canadian producers who will suffer, particularly those with too much debt and few forward sales.

Advantage Energy (AAV.TO) ( OTCPK:AAVVF) is a favorite of Canadian energy analysts combining excellent acreage in the Montney area with a unique subsidiary engaged in Carbon Capture named Entropy. The company offers low costs, fast payouts on new wells, and plans share buybacks. What could go wrong?

Advantage Energy overview (Company website presentation)

Low natural gas prices could go wrong for Advantage. While Advantage has a small hedge book, it covers barely 10% of the projected output by my estimation.

Despite its low operating costs, Advantage has significant leverage to gas prices. I have modeled the company's operations based on a realized average price of CDN$2.00 a gigajoule for gas and CDN$80 a Boe for oil, and the company's budgeted CDN$290 million capital program for 2024. If natural gas production becomes congested at AECO or other gas hubs ( as has happened in the past summers) prices could go very low and even negative for short periods.

I estimate the value of AAV shares at CDN$5.39 per share based on a realized average price of CDN$2.00 per mcf. That may be optimistic if AECO becomes congested this summer. I have used a multiple of 4 x EBITDA to calculate Enterprise Value (EV).

Summary Model (Blair analysis)

Advantage Energy shares currently trade at CDN$9.01 a share.

There is little Advantage Energy management can do to affect natural gas prices for the balance of this year other than to add hedges that lock in poor performance. Natural gas in storage is about 15% higher than the five-year average, winter is ending in just weeks, and the summer months are rarely constructive for natural gas prices.

If I am correct that prices will average no more than CDN$2.00 per mcf for gas, Advantage cash flows of CDN$255 million will not cover capital outlays of CDN$290 million and will not fund planned buybacks without adding debt.

This article suggests Advantage Energy is a good short based solely on the risk of lower natural gas prices persisting for the balance of this year. Short positions carry the risk of a short squeeze, can be called at any time if the dealer one used cannot borrow the shares needed to sustain the short, and volatile commodity markets could see higher prices for a plethora of unforeseen reasons including production curtailment by producers, pipeline failures, and legislative actions that curb output.

I like the risk - reward and have a short position of 30,000 shares.

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