Producers with high short interest are flying
The Spider Oil and Gas ETF (XOP) diverged from natural gas prices. It rose 1.41%—mainly tracking oil. Both commodities’ long-term fundamentals continue to be extremely weak. The EIA (US Energy Information Administration) reported that production is set to increase by 5% in the coming year. It’s estimated that the ETF’s components will collectively produce 50 Bcf (billion cubic feet) of natural gas per day in the coming year—an almost 10% increase over the last 12 months.
The EIA might have been too conservative in its estimate. There are four companies within XOP that reported a natural gas production mix above 90%. The companies include Southwestern Energy (SWN), Cabot Oil & Gas (COG), Ultra Petroleum (UPL), and EQT Corp. (EQT). On average, they fell 2.18%—tracking both May natural gas futures as well as the United States Natural Gas Fund LP (UNG). Of these companies, Ultra Petroleum has the highest short interest versus total float with a ratio of 18.64%.
Also, there seems to be profit taking and relative value rebalancing in the energy markets. The firms within the ETF that have short interest ratios above 20%, averaged a 10% return in the last five days alone. This compares with a 3.06% average return for companies with short interest ratios below 20% within XOP.
Natural gas prices are under pressure
Natural gas prices are under significant pressure due to a shorter winter season, rising inventories, and weakening demand. Natural gas producers with the highest short interest ratios—like Chesapeake Energy (CHK), Ultra Petroleum (UPL), and EXCO Resources (XCO)—separated themselves from natural gas fluctuations. The May natural gas futures contract lost 4.2% this week. This drove the loss of 4.33% in UNG.
Drilling down on valuations of natural gas producers that have a high percentage of natural gas versus total energy production reveals that the market has drawn a clear line between large and small cap gas producers. Companies that have a natural gas mix above 65% and a market cap above $8 billion are trading at an average PE (price-to-earnings) ratio of 26x. This compares to 18x for companies with similar production mixes, but under a $4 billion market cap.
What does it mean?
Given the fall in gas prices, it’s widely assumed that larger companies will be better positioned to withstand any potential cash flow issues. The cash flow issues are due energy prices collapsing.