5 stocks fired up by energy mergers - Jubak's Journal

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Posted 12/14/2005

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Jubak's Journal
5 stocks fired up by energy mergers

ConocoPhillips is paying $35 billion to build its natural gas stake. Here are five other stocks likely to benefit from continued consolidation in the gas fields.

By Jim Jubak

An already hot market for natural gas stocks got a lot hotter this week -- and I don't think it's going to cool down any time soon. Yes, the stocks are up big. But three powerful trends will push them higher in the first few months of 2006.

I've been pounding away at these three trends separately in my recent weekly appearances on CNBC's "Morning Call." ConocoPhillips' (COP, news, msgs) $35 billion bid for Burlington Resources (BR, news, msgs) shows that even a stock like Burlington that's up 25% in the last month can look like a bargain when you put all three trends together.

Last week, you might remember, I told viewers on CNBC and readers on CNBC.com on MSN Money about one of those trends: That, suddenly, the continental United States is the hot spot for natural gas exploration and production. Giants such as Exxon Mobil (XOM, news, msgs) and independents such as Forest Oil (FST, news, msgs) have decided to reallocate their exploration drilling dollars from overseas projects to the onshore market in the United States.

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Most of Burlington's gas reserves are located in the Rocky Mountain gas zone that stretches through the United States and Canada. The purchase will increase ConocoPhillips' gas reserves by 50% and turn the company into the top North American gas producer. ConocoPhillips paid a 20% premium for Burlington Resources -- and a high-end price of almost $3 per thousand cubic feet of natural gas reserves. It was willing to do so because, ConocoPhillips CEO James Mulva said, Burlington Resources' low-risk North American gas reserves will balance the higher political risks of ConocoPhillips' projects in Venezuela and Russia.

At the end of September I told viewers and readers about a second trend: High energy prices have made it economical to produce the natural gas trapped in tough-to-drill rock formations in the United States, what the industry calls unconventional deposits. These deposits -- discovered long ago but bypassed because getting at the gas was too expensive -- are, suddenly, the hot place to drill in the United States.

Burlington Resources, no surprise, owns a big hunk of one of these unconventional deposits, the Barnett Shale formation of north-central Texas.

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Let's talk about the weather
Cold weather, the third trend I flagged for you in my Nov. 9 spot on "Morning Call," returned just in time -- it's 17 degrees in New York as I write this -- to put even more heat under the price of natural gas and the price of natural gas stocks. During what's called the shoulder period, energy inventories build up if producers and refiners run at full speed to get a head start on winter demand but winter weather itself is slow to arrive. That's exactly what happened this year as mild weather gripped the country for much of November. But normal cold temperatures are back and so are big drawdowns of inventory. Next week's drawdown of natural gas inventories has a good chance to break records. Natural gas futures for January delivery ran to a record $15.38 per million BTUs on Dec. 13 and a big drawndown in the next few weeks could push natural gas futures toward $20 per million BTUs. Huge spikes like that in the futures market usually drive the prices of natural gas stocks higher.

With both the short-term (natural gas prices) and long-term (the boom in North American and unconventional gas reserves) hard at work, the ConocoPhillips bid for Burlington Resources is certainly not the end of acquisitions in this sector.
The only question: Who's next?
Size doesn't much matter. If you're the size of a ConocoPhillips, buying a small independent won't make much of an addition to existing reserves. So these companies will go after acquisitions the size of a Burlington Resources. Big independents that want to keep their independence, such as Canada's Encana, will make smaller acquisitions, adding debt that makes them less attractive as acquisitions. Smaller independents will be on the move, too, to make deals that put them on the radar screens of potential acquirers.

And, of course, everyone will be looking to add reserves before they get even more expensive.

On my regular Wednesday morning appearance on CNBC's "Morning Call," I flagged these three natural gas acquisition candidates as stocks to buy for the next six months.

Carrizo Oil & Gas (CRZO, news, msgs). With a market cap of just below $700 million, Carrizo Oil & Gas is a quick mouthful for a larger independent looking to build a quick position in unconventional natural gas reserves in the United States. This company's major unconventional asset is leases and lease options of 80,000 acres in the Barnett and Woodford Shale formations in north Texas. What makes this field unconventional? Natural gas companies have had to drill deeper than they initially expected and to employ expensive and initially experimental techniques for fracturing the shale to get at the gas. Using price comparisons from recent deals, by XTO Energy (XTO, news, msgs) and Chesapeake Energy (CHK, news, msgs) Carrizo's oil shale gas reserves are worth $32 to $40 a share. The company has also been adding leases in another promising oil shale formation in Mississippi, the Floyd Shale formation. Our StockScouter rates these shares a 5 out of a possible 10.

Quicksilver Resources (KWK, news, msgs). With its $3.5 billion market cap, Quicksilver Resources brings a portfolio of proved reserves of 968 billion cubic feet of natural gas equivalent (about 92% is actually natural gas.) But it's the company's holdings of oil shale that are the gem in the portfolio: Oil shale in Michigan, Indiana, Kentucky and Texas accounts for about 680 billion cubic feet of the company's natural gas reserves. And the figure for proved reserves really doesn't reflect the company's acquisition of a huge 300,000 acres in the Barnett and Woodford shales of West Texas. The company planned to have completed seismic data collection on about 40% of its Barnett acreage by the end of 2005 with another 40% of the holdings scheduled for data collection in 2006. That will give Quicksilver a better idea of what it's got under those acres and will allow the company to expand drilling to 10 rigs in 2006. Our StockScouter rates these shares a 6 out of a possible 10.

Pioneer Natural Resources (PXD, news, msgs). Pioneer Natural Resources, another step up the market capitalization ladder to $7 billion, has become a much more attractive acquisition in the last year or so because of what the company has bought and sold. In September 2004, Pioneer's merger with Evergreen Resources brought the combined company a portfolio of exceedingly long-lived unconventional natural gas assets. In this case, the gas isn't locked up in oil shale but in coal beds. (The geologic process of turning ancient plants into coal produces quantities of methane gas that is stored in the coal deposits themselves.) And there's a lot of gas in those coal beds. The company estimates that it will be able to double production from its Raton coal-bed methane field over the next five to six years, and that the field has an estimated reserve life of 30 years. Pioneer also has unconventional natural gas projects in Canada's Horseshoe Canyon and the Uinta and Piceance basins owned by Evergreen. Just as important, though, Pioneer Natural Resources is making itself into a much more attractive acquisition candidate by selling off its deep-water assets. When that process is completed in 2006, Pioneer Natural Resources will be a tasty morsel for a bigger oil company. Our StockScouter rates these shares an 8 out of a possible 10.

Video: Jubak on "Stocks fired up by energy mergers"

As always I have two more "exclusive" picks for readers of CNBC.com on MSN Money.

EOG Resources (EOG, news, msgs). With EOG, an acquirer would spend more -- the company's market capitalization is $19 billion -- but get a much more finished unconventional natural gas product. While smaller Barnett Shale producers such as Carrazo Oil & Gas are looking for capital to expand their initial drilling plans, EOG has announced huge production from its Barnett wells at flow rates almost twice those projected in September. EOG has reported that its total Barnett acreage is now 503,000 acres, but the company is keeping another acquisition effort very close to its vest. EOG will say only that it holds 125,000 additional acres somewhere outside the Fort Worth basin in Texas. The company has said that it is flow testing a well in this area and will reveal results from this test on its February 2006 earnings call. As of Dec. 1, according to J.P. Morgan, EOG was one of the few oil or gas companies that was un-hedged for 2006 -- which means that EOG will get the full benefit or suffer the full damage from any move in natural gas prices. Our StockScouter rates these shares a 9 out of a possible 10.

Chesapeake Energy (CHK, news, msgs). Let's get this straight: I don't expect Chesapeake Energy to be acquired by anyone anytime soon and I think Chesapeake Energy is pretty much finished with its own acquisition binge. So why put it on this list? Because every higher-priced acquisition from here on validates Chesapeake Energy's earlier acquisitions. For example, in a deal that closed on Dec. 1, the company acquired 1.1 trillion cubic feet of natural gas equivalent in proven reserves in the eastern United States with its purchase of Columbia Natural Resources. The cost of $2.20 per thousand cubic feet compares favorably with the nearly $3 that ConocoPhillips just paid. Plus, Chesapeake Energy has acquired another 200,000 acres in the Fayetteville oil share formation, bringing its total position to 600,000. Our StockScouter rates these shares a 9 out of a possible 10.

Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.
E-mail Jim Jubak at jjmail@microsoft.com.

At the time of publication, Jim Jubak owned of controlled shares in the following equities mentioned in this column: Chesapeake Energy.

MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.