2023-11-13 09:46:15 ET
Summary
- The company has transportation advantages that extend beyond the LNG corridor, with exposure to other locations with premium pricing.
- Antero Resources has the potential to earn higher-than-usual profits from winter storms and cold snaps, capitalizing on the volatile nature of natural gas prices.
- Share price dynamics: why AR is probably the best buy for natural gas bulls.
- AR is undervalued based on the natural gas futures strip.
Introduction
Antero Resources ( AR ) generates hundreds of millions USD from a single winter storm. It is undervalued based on the current natural gas futures strip, and its share price was penalized more than that of other natural gas producers when natural gas prices fell earlier this year. AR remains a buy due to its best-of-class transportation capabilities, allowing the sale of natural gas at a premium, coupled with its strategic decision to remain unhedged.
Why Antero Resources Can Sell Natural Gas at a Premium
AR demonstrates strong logistical capabilities by channeling 75 percent of its natural gas production into the LNG corridor. More specifically, AR focuses on Tier 1 pricing points along the Gulf Coast, resulting in highly profitable pricing. As highlighted in their recent earnings call :
Based on the current strip, Tier 1 prices reflect increasing premiums to NYMEX in 2024 and 2025, including the TGP 500 line, where premiums have increased to $0.29 above NYMEX in 2026
Furthermore, AR's transportation advantages extend beyond access to the LNG corridor. They also have exposure to other locations with premium pricing, as emphasized in another citation from the earnings call:
We also have quite a bit going to Chicago during the winter, which may be up to $0.50 ahead of Henry Hub right now, and we're bringing seven wells on in the Utica just in time to enjoy the Chicago gas prices filling our ex capacity
In the past, AR's transportation excellence typically resulted in selling their natural gas at a premium compared to Henry Hub NYMEX prices, something that most natural gas producers can only dream of achieving. However, during the last quarter, their natural gas was sold at a price $0.07 cheaper than the NYMEX price. According to the earnings call, this was a one-time unfortunate event resulting from simultaneous maintenance at the Cove Point LNG Terminal and extended maintenance on a Gulf Coast-directed pipeline during the quarter. Consequently, a significant amount of natural gas could not be sold at the "expensive" locations.
Profits from Winter Storms
It seems that more frequently, however, stochastic events provide AR with opportunities to earn higher-than-usual profits. Winter storms and cold snaps, which sometimes lead to massive freeze-offs due to the freezing of water and other substances in the natural gas mixture, are prime examples. Let's examine three such events that occurred in the past (marked in the price graph below) and evaluate how they would impact AR's free cash flow if they were to occur now, with the company producing 2.4 billion cubic feet per day of natural gas.
For that purpose, the daily natural gas production was multiplied by the price premium and by the corresponding number of days. That is, extra profit due to a higher NYMEX price was estimated from the area beneath the corresponding peaks marked on the price graph. Additionally, AR reports its premiums to Henry Hub NYMEX prices in its quarterly press releases , and this data was used to estimate extra profit arising due to a higher premium to NYMEX. In the subsequent calculation, I attributed all excess of this premium over the previous quarter to the specific event. These premiums and resulting profit estimates are summarized in the table below.
It can be seen that the extra profit due to the higher premium over NYMEX prices amounts to several tens of millions of dollars per event, indicating that AR is well-positioned to capitalize on the volatile nature of natural gas prices. The total extra profit is measured in hundreds of millions of USD. Is this a substantial sum? I prefer to think of it this way: at the beginning of this year, natural gas prices experienced an exceptionally strong downfall, reaching very low levels. Unhedged, AR posted a negative free cash flow of $159.497 million in its worst quarter. Thus, one of the weather events considered above could compensate for the worst quarter of this year. And it seems that such weather events occur more frequently than such natural gas price declines.
Time and type of event | Premium to NYMEX price, event quarter, USD | Premium to NYMEX price, quarter before event, USD | Extra profit due to higher NYMEX price, million USD | Extra profit due to higher premium to NYMEX, million USD | Total extra profit, million USD |
Cold snap with freeze-offs, Q1 2018 | 0.14 | -0.13 | 70.52 | 56.67 | 127.19 |
Prolonged cold snap, Q4 2018 | 0.19 | 0.05 | 105.45 | 29.38 | 134.83 |
Cold snap with massive freeze-offs, Q1 2021 | 0.41 | 0.10 | 170.18 | 65.05 | 235.23 |
Of course, the substantial profits AR derives from these weather events only partially explain why, unlike other natural gas producers, they prefer to remain unhedged for now. They expect increased Henry Hub prices in the future given depressed drilling activity in Haynesville , a basin with high production costs. Right now we are still in a period with a surplus of natural gas in storage, which historically exerts downward pressure on natural gas prices. In a previous article , I argued for natural gas prices to rise more than the current market expectations when the deficit returns. Given that historically, deficit periods tend to last several quarters, the next one could prove highly profitable for AR.
On top of their access to various natural gas markets and their lack of hedges, AR has the option to get more exposure to natural gas liquids or natural gas. While changing the proportion between NG and NGL production takes time, it does not take forever. For example, AR's liquids production grew by 18% in the last quarter compared to the same period a year ago, whereas natural gas production only increased by 4%.
AR Share Price Performance
A quick observation of the graph below reveals that AR shares exhibited significantly weaker performance over the past year compared to those of other producers, with the exception of CRK. No adverse events impacted AR's business operations, except for being unhedged during a period of low natural gas prices, while others are hedged to some level. It is no surprise that, this year, the market favors the 'golden' hedges established in 2022, leading to corresponding adjustments in stock prices.
If natural gas prices rise again, the situation may reverse, transforming AR's unhedged position into an advantage. That's why I believe that, for natural gas bulls, right now AR represents the best investment opportunity among natural gas producers.
Valuation
Not surprisingly, AR's potential earnings heavily depend on the prices of the basket of their products, with natural gas being the most significant. As mentioned earlier, they faced negative FCF in Q2 of this year amid unsustainably low prices. Conversely, in 2022, they generated almost 2 billion USD in FCF. During 2022, AR's realized price for natural gas was as high as 6.9 USD/Mcf before hedges, yet the actual sale occurred at only 4.54 USD/Mcf (refer to their quarterly press releases), a result of hedges from previous years.
At present, natural gas futures for 2025 and 2026 average well above 4 USD/Mcf Given AR's current unhedged status and slight production growth, an expectation of 2 billion USD in FCF annually in the coming years seems reasonable if those years prove to be neutral for natural gas prices. This equates to a 20-25% FCF yield, enabling AR to rapidly reduce their 1.6 billion USD debt.
Risks
The most substantial risk lies in a prolonged period of natural gas glut and, consequently, low natural gas prices. This could be triggered by global LNG oversupply, an increase in the production of associated gas, and/or faster-than-expected development of renewables. A company-specific risk worth mentioning is the potential reduction in production costs in the Haynesville Basin due to technological innovation. While this would be beneficial for companies operating in Haynesville, it poses a challenge for AR, which views Haynesville as a swing Basin at today's production costs.
Conclusion
I recommend buying AR at current levels. Nonetheless, it remains a highly volatile stock, with share prices fluctuating significantly due to changes in weather forecasts over the next two weeks. The decision to invest immediately or wait for warmer weather forecasts or even a mild winter is a personal one,
For further details see:
Antero Resources: Well-Positioned To Profit From Natural Gas Price Volatility