Energy Prospectus

The Sweet 16 had a good week, up 3.21%, but it is still down 25.94% YTD.

I have updated all of the Sweet 16 forecast models. They should all report positive EPS for the 2nd quarter. CLR and EOG have the most exposure to the dip in oil prices because none of their oil is hedged.

Best buys look like GPOR, CRZO, AR, RRC, CLR and NFX. All of them are trading at less than 50% of my valuation. Wall Street still has not figured out how tight the U.S. natural gas market is going to be heading into winter.

Let me be clear: I expect a near-term spike in natural gas prices, but I do not think gas is going to get back to 1/6th the price of oil anytime soon or ever again. We have a lot of natural gas reserves in this county; over 100 years of supply. What's just ahead is a period were demand exceeds "production capacity" for a winter heating season. Reserves in the ground and production capacity are two very different things.

Gulfport Energy (GPOR) is currently not getting any credit for the potential they have in SCOOP. Trust me, it is HUGE. Their first two company operated wells are "kick ass good" and they have over 500 Woodford horizontal drilling locations just like those two. Gulfport reported 31.5% production growth in 2016. The company is going to report 45% to 50% production growth this year. Q1 production was 141,594 BOE per day and they will exit 2017 with production over 220,000 BOE per day. < This is based on the mid-point of the company's guidance.

Credit Suisse put out a detailed report on Gulfport on 3/31/2017, before the results of the two big Woodford wells were known. They rated it a BUY with a $33 price target. Today, the outlook for natural gas and NGLs is better. Gulfport's production mix is 88% natural gas, 8% NGLs and 4% crude oil. If crude oil prices go to $0/bbl for all future periods, my valuation of GPOR drops from $40 to $36. BTW lower oil prices actually improves the outlook for natural gas.

Hi Dan, Re: "Let me be clear." (" I expect a near-term spike in natural gas prices, but I do not think gas is going to get back to 1/6th the price of oil anytime soon or ever again. We have a lot of natural gas reserves in this county; over 100 years of supply. What's just ahead is a period were demand exceeds "production capacity" for a winter heating season. Reserves in the ground and production capacity are two very different things.")

If the mkt is also thinking that a supply crunch will be temporary, is it likely that a "spike" in natgas prices would bring about only a weak paradigm shift of investment in this sector? After all, investors have had a multi-year experience of oversupply, and propaganda about US "dominance" and no-holds-barred production encourages belief in low prices. Sounds like investors in gassers may be all trying to outguess when to dump natgas shares toward the end of the season. Care to compare the prospective season to past egs? Or speculate about RRC or another model?

The natural gas market in the U.S. has very little to do with the oil market. Some people think the collapse in natural gas prices and NGL prices was directly related to the oil "glut". The natural gas "glut" was more weather related.

First, let's look at why natural gas prices crashed at the end of the 2015-2016 winter heating season.
> The winter started with a lot of gas in storage, about 250 BCF above the 5-year average
> It was a "Super El Nino Winter", mild December, some cold in January and then mild February & March
> Winter ended with over 500 BCF more gas in storage than the 5-year average
> At the same time we had high associated gas production, primarily in the South Texas Eagle Ford that depressed Henry Hub prices
> It was a "Perfect Storm" of bad stuff happening for the natural gas producers
> On top of that, the Marcellus/Utica producers like AR, EQT, GPOR, and RRC were forced to take big discounts for their gas because of midstream capacity shortages.

This year:
> U.S. gas production is down ~2.0 BCF per day and demand is up over 2.5 BCF per day
> Two new pipelines now take Texas gas to Mexico. 4.5 Bcf today and rising to 7 Bcfpd within a couple of years.
> Eagle Ford associated gas is way down, ~2.0 BCF per day.
> LNG exports are on the rise
> Marcellus/Utica producers have access to better markets

Take a look at slide 8 from my July 14 podcast and you can see that gas in storage is getting closer and closer to the 5-year average. As of July 7th natural gas in storage was 172 BCF above the 5-year average, but we are moving closer by about 2 BCF per day. So, in about 86 days U.S. natural gas storage s/b very close to the 5-year average. July 7 + 86 days is October 1st. That is way before winter heating season begins. If we have some weekly draws from storage late in July or early August, it will happen earlier.

Now the good news: WE USE A HELL OF A LOT MORE GAS THAN WE DID FIVE YEARS AGO. Primarily because natural gas has replaced coal as the #1 fuel for power generation AND we are exporting more gas. Natural gas exports are around 7 BCF per day now and export capacity will rise to 19 BCF per day by 2020. It is access to global markets that I think will keep natural gas prices from crashing in the future.

Utility companies do have the option in some areas to switch back to coal for power generation, but a lot of coal fired power plants are now gone. Across the South we have lots of gas fired peaking plants that are needed to respond to spikes in demand for electricity, when everyone runs their AC units 24/7. Peaking plants burn up a lot of gas.

See slide 9 in my 7/14 podcast

In the near-term, I think it will become clear to everyone that we are going to begin the winter heating season with a MUCH LOWER amount of gas in storage than we had last November. As Mark Fisher told CNBC last week, a normal winter should push ngas over $4.00/MMBTU. If Mother Nature is kind enough to give us a cold December in the Great Lakes area, then we could see utilities bid up the price to over $5.00/MMBTU. In December, 2013 and January,2014 we saw spot prices over $8.00/MMBTU.

So, what happens then? More access to the global markets (pipelines to Mexico and Canada + growing LNG capacity) should remove the risk of a "glut". I doubt that the big producers will go crazy with drilling programs unless they can lock in good prices with hedges. So, if this plays out according to my "vision" of the future, we should see a floor for natural gas of around $3.00.

If you believe natural gas will stay above $3.00, then AR and RRC are "Screaming Buys" at their current share prices.

Back to "Reserves in the Ground are not Production Capacity".
> The big natural gas producers are not going to accelerate drilling programs without a gas price that gives them a good return on their capital.
> I do not see the associated gas issue being the same threat that it was. Drilling in the Eagle Ford is way down from where it was and there is growing demand from Mexico. We had the Texas Railroad Commissioner speak at one of our recent luncheons in Houston. He said that Mexico would love to have 7 BCF per day.
> Industrial demand for gas along the Gulf Coast is going way up. Natural gas and NGLs are feedstock for the petrochemical business, which is HUGE in the U.S.

I know this is a lot of rambling. I hope it was helpful.

GPOR is different than AR, RRC and EQT. GPOR's share price will have more to do with their SCOOP well results.