Natural gas reserves still have a big advantage

After an epic, pandemic-induced crash in 2020, the US stock market has returned to winning ways and the current year is once again enjoying another peak season. The S&P 500 is already up 16.0% in the year to date and is constantly hitting new all-time highs.

However, few market segments have outperformed the long-suffering energy sector. After years of underperformance, the energy sector has performed very well in the current year with the Energy Select Sector SPDR ETF (NYSEARCA:XLE) Up 30.0% YTD, Second Only to Retail Sector Gain of 49.8% YTD SPDR S&P Retail ETF (NYSEARCA:XRT).

The Delta variant of Covid-19 has cast a dark shadow on the entire market. However, analysts say the latest wave of infections has yet to translate into a decline in spending, with most consumer spending metrics, such as air traffic, dining out and movie checkouts, still positive.

After a period of heightened volatility due to an OPEC+ dispute over production levels, the energy sector is recovering, with Wall Street remaining largely optimistic about the medium-term outlook.

The oil sector has been in the spotlight lately after last year’s crash sent oil prices into negative territory. However, the natural gas sector was even more impressive, with the most famous being wet. gas benchmark, the United States Natural Gas ETF, LP (NYSEARCA:UNG) was up 48.6% YTD on the back of an ongoing natural gas rally.

Natural gas futures traded at $3.95/MMBtu on Thursday, putting them on track for their fourth straight month of solid gains. Natural gas is up 63.4% from the start of the year and up 135.7% from a year ago, with prices back to where they were last traded in December 2018, when gas was last above $4 was traded.

If you look closely at those numbers, you’ll notice that natural gas stocks have lagged nearly 15 percentage points so far this year from the commodity they are tracking and a whopping 95 percentage points in the past 12 months.

That apparent anomaly can be attributed to the fact that natural gas stocks trade based on the price of longer-dated futures. While short-term futures tend to fluctuate based on short-term dynamics, such as weather, equity investors are more concerned about what the market might look like in 18 months or more.

With this in mind, this is why many natural gas stocks could actually be undervalued right now.

Bullish outlook for natural gas

It is a well-known fact that the fossil fuel sector is by far the largest contributor to greenhouse gas emissions. In fact, the EIA has released a damning report that in 2018 carbon dioxide (CO2) emissions from fossil fuel combustion were equivalent to ~75% of total anthropogenic greenhouse gas emissions in the US and ~93% of total anthropogenic CO2 emissions in the US (based on 100 years of global warming potential ).

Over the past half decade, natural gas producers have rebranded and touted the feedstock as the perfect energy bridge that will continue to play an important role in our energy mix as the world gradually adopts cleaner energy sources. Natural gas emits 50 to 60 percent less CO2 when burned in a new, efficient natural gas plant compared to the emissions of a typical new coal plant.

Unfortunately, this story has been greatly compromised in recent years, thanks to the rapidly falling costs of renewable energy. Photovoltaics (PV) has seen the sharpest cost reduction of all electricity technologies in the past decade, with a report from the International Renewable Energy Agency (IRENA) saying that between 2010-2019, the cost of solar photovoltaics worldwide will increase by 82%. have fallen. If renewable energy production were to reach cost parity with natural gas, it would lose its last line of defense as an energy bridge, because natural gas is still orders of magnitude dirtier than the dirtiest renewables when taking into account emissions throughout its life cycle.

Fortunately for oil and gas bulls — and much to the chagrin of clean energy enthusiasts — the trend of rapidly declining solar costs seems to have come to an abrupt end.

Clean energy funds have been hit hard Enphase Energy Inc. (NASDAQ:ENPH) — a popular holding company — reported major semiconductor shortages and supply chain problems. ENPH went through one of its biggest one-day crashes after dropping nearly 10% a day after reporting better than forecast Q1 profit but spend downward guidance for Q2 due to semiconductor shortages and supply chain problems that were worse than expected.

A global shortage of semiconductor chips has wreaked havoc on the tech sector, clean energy, the automotive industry, the consumer electronics industry and everything in between. After years of lukewarm demand, the COVID-19 pandemic sparked a massive wave of tech purchases, taking manufacturers of personal computers, tablets, laptops and game consoles by surprise.

However, the bottlenecks in the supply chain can pose a risk in the short term.

Following checks with utility-scale solar developers including: Matrix technologies (NASDAQ:ARRY), The only FTCr (NASDAQ:FTCI), and Shoals technologies (NASDAQ:SHLS), Cowen analysts have lowered their earnings estimates for the fourth quarter of 2021 and the first half of 2022, as most of the third quarter’s second-quarter revenue was booked pre-inflation. leading to 6-9 month push-outs for solar projects. Analyst Jeffrey Osborne says he sees “more resilience” in residential exposure.

Related: The Net-Zero Story Is Full of Holes

However, Cowen says their checks on utility-scale property developers suggest that long-term trends remain “incredibly encouraging.”

Still, there could be other secular headwinds in the long run that could limit growth for the sector.

The solar industry is now mainly focused about making panels more powerful as it continues to squeeze as much efficiency as possible out of solar technology. However, according to Xiaojing Sun, global solar energy research leader at Wood Mackenzie Ltd, the reduction in the cost of module prices has slowed significantly over the past two years. It is now the reductions in electricity costs that provide much of the benefit to solar. This constraint means that the cost of solar is unlikely to fall low enough to outperform their oil and gas rivals, even if oil prices didn’t rise any higher.

The hydrogen ally

Last year, the European Union adopted its new hydrogen strategy as part of its goal to achieve carbon neutrality for all its industries by 2050.

In a major victory for the renewable energy sector, the EU has set a highly ambitious target to build at least 40 gigawatts of electrolyzers within its borders by 2030, or 160x the current global capacity of 250 MW. The EU also plans to support the development of an additional 40 gigawatts of green hydrogen in nearby countries that can export to the region by the same date. The EU aims to have installed at least 6 gigawatts of clean hydrogen electrolysers by 2024.

Good news for natural gas companies: While Brussels is clearly in favor of “green” hydrogen produced by renewable energy, it has indicated that it will also encourage the development of “blue” hydrogen produced from natural gas in combination with carbon capture and storage (CCS).

The EU has said hydrogen will play a key role in decarbonising manufacturing and transport. The organization says it supports blue hydrogen during a ‘transition phase’. While natural gas producers undoubtedly prefer centralized blue hydrogen, they won’t complain too much, as natural gas infrastructure can be easily reused to transport hydrogen.

The latest decision from European policymakers follows years of hard lobbying by more than 30 energy companies, including ExxonMobil (NYSE:XOM), Eni (NYSE:E), Shell (NYSE:RDS.A) Total (NYSE:TOT), Equinor ASA (NYSE:EQNR) and other European natural gas companies who have called for a “technology neutral strategy” arguing that renewables such as wind and solar cannot grow fast enough to power the “clean hydrogen” sector to meet the decarbonisation targets. make to get. The signatories have argued that the green hydrogen industry is currently too small to fuel the growth of a large-scale European hydrogen economy in just a decade.

Top Natural Gas Stocks

Against this background, we believe that natural gas is likely to continue to play an important role in the US energy mix as the dominant fuel for electricity generation for many years to come.

John Gerdes, oil and gas analyst at MKM Partners, has opted for Antero Resources (NYSE:AR) and Southwestern Energy (NYSE:SWN) as the stocks trading at the largest discount to their implied value relative to the gas price.

Our top picks in space are Cheniere Energy (NYSE: LNG), EQT Corporation (NYSE:EQT), Range Sources (NYSE:RRC), and Cabot Oil & Gas Corporation (NYSE:COG).

By Alex Kimani for Oilprice.com

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