Reading the Nat-Gas Situation

 | Jul 30, 2012 | 11:29 AM EDT
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Is what's good for natural gas bad for Lufkin Industries (LUFK)? Today Lufkin is getting killed, and among a multitude of reasons is the dramatic slowdown in drilling for natural gas in this country.

Meanwhile, Southwestern Energy (SWN), Cabot Oil & Gas (COG) and Range Resources (RRC) are roaring ahead among other natural gas plays. They are two sides of the same story.

What's going on? First, you may not know Lufkin, but you know one of its products. Lufkin makes the "donkeys," the things that go up and down to bring out the oil or the natural gas once the drilling is done.

Lufkin is a piece of the nat-gas chain, like everything from Halliburton (HAL) to Heckmann (HEK), and the business has been horrendous as the rigs and the services shift quickly to the oil plays in this country, not the natural-gas plays, because we are saturated with natural gas and have no place whatsoever to put it.

Unless we stop drilling, the pure plays are going to continue to be obliterated. That's what's so surprising about the action in the major nat-gas plays. They are roaring, as are some of the pipelines deeply linked to natural gas use, such as Inergy Midstream (NRGM) and Energy Transfer Partners (ETP), and it's difficult to conclude anything other than that the glut will be cured by excessive heat and by the quick decline in drilling.

That natural gas market has been a real bust of late. We know that Chesapeake Energy (CHK), the natural gas company, has been trumpeting the swiftness with which it is moving to be more oily. So is EOG Resources (EOG). The first has a not-so-hot balance sheet; the second has a better one and therefore has more wherewithal to make the switch.

We also know that Exxon Mobil (XOM) sounds like it is backing away from natural gas after paying top dollar for XTO not that long ago when natural gas was at $9. On the call, an analyst actually had the audacity to question whether there should be a write-down of the assets there, something that Exxon immediately denied.

Could natural gas be bottoming for real? I have been thinking more and more that it is, except that it's bottoming not for good reasons. The marginal demand for nat gas right now is coming from the heat. Air conditioning is running around the clock in the scorched areas of this country. Utilities use natural gas as a peak fuel just for this kind of short-term air-conditioning demand. Otherwise, coal remains the true baseload fuel. Unless President Obama is re-elected and gets the EPA to close all coal plants, I think this kind of demand will be ephemeral.

What's really needed is a commitment to use natural gas as a surface fuel, and the company that could have done the most to promote it is Exxon, because without a national chain that has thousands of stations, natural gas can't be adopted for anything but a small long-haul trucking business as well as city buses and garbage trucks. But Exxon seems to have no interest whatsoever in doing so.

That means, to me, that the supply shut-in and the heat are creating the rally, and more drilling and cooler weather will reverse the trend. So while Lufkin is a signal that the nat-gas drilling phase is winding down, the demand side must change before a real bottom can be called.

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