Panic Stricken Brokerages Fueling the Market Destruction
A classic case of what is happening with this market appears evident with stocks like Paramount Energy who watched helplessly as their price fall through that critical $3 mark (threshold required for marginability). This occurred on Friday and brokerages like TD apparently wasted no time actually phoning their clients this weekend to tell people that their positions would be forcibly sold out if they didn’t cover them on Monday.
This is becoming an all too common occurance for investors who carry any debt in their brokerage accounts. These brokerage firms are already suffering with lost business but now they are putting the nail in the coffin of many investors (and public companies) who are watching helplessly as stocks drop to bizarre levels – often fueled by the brokerage themselves and computerized (black box) trading.
So that now begs the question… how attractive do some of these stocks become. To try and answer that we’ve taken a look at Paramount – a pure play on natural gas.
Paramount Energy Trust (PMT.UN $2.75)
The number of drills working in North America is dropping dramatically and I've spoken to numerous people in the oilpatch this month who confirm the slowdown in the field is nothing like they expected. Most companies shut down over Christmas and have yet to call their guys back to work. Next month we will see spring breakup in Western Canada so that means another month of no rig movement.
I suspect the producers are planning to curtail new drilling and workovers for all of Q1 and extend it into spring breakup. I even talked to a few guys this past week in booming areas of Southeast Saskatchewan who said they are not even doing maintenance work that isn't critical. In Alberta gas fields of central Alberta the crews are laid off and service rigs litter the rig yards from Medicine Hat to Calgary and around Red Deer.
This will begin to take a lot of the oversupply out of the system but will take a few months. If we get hot weather this summer throughout the United States, we will see a spike in power consumption that will draw down gas inventories even further.
The next important part of the equation should begin to surface by spring and early summer - mergers and acquisitions in the oilpatch.
Canadian Natural Resources (Canada's 2nd largest natural gas producer) just reported dramatic cuts in capital spending for 2009 but also $1.8 Billion in net income for 2008. Their goal is to reduce debt so they can take advantage of distressed assets as the economy weakens. They stated it is cheaper for them to buy reserves and production at these prices than it is to drill.
I have heard similar comments about giants like Imperial Oil who may start to look at acquiring smaller to mid tier producers by this spring or summer. A tremendous amount of cashflow was generated in 2008 and even at these prices the companies are making good money.
This doesn't mean to say companies like Paramount Energy will become acquisition targets, but the lower the stock price stays, the more appealing it becomes. Drilling is expensive and mergers and acquisitions provide the immediate benefit of:
production / cashflow
reserves / extensive infrastructure
synergies in the field and shared administration
At $2.75, PMT.UN yields 30% annually if they could sustain $0.07 per month distributions (the February level). However, even if this was cut to $0.04 until gas prices improved, the yield is still 17%. This then provides an income stream and an opportunity to play a rebound in the price of natural gas this summer or increased merger and acquisition activity in the oilpatch.
I have seen no indication that they plan on cutting the distribution entirely but even as a worse case scenario and if that occured, it would allow them to focus on reducing debt and with strong cashflow, still makes them an excellent play on natural gas or possibly an acquisition target this year.
Fundamentals of Natural Gas
- If you are planning on moving into a new apartment or house in most states, you are required - by law - to have your gas and electricity turned on before you can spend your first night. The economy affects demand but as a matter of survival in North America, people need food, water, electricity and heat.
- In line with Obama's economic and environmental plans, natural gas produces 29% less carbon dioxide than petroleum and 44% less than coal.
- In 2007, Congress worked its way through a bill mandating a ridiculous amount of ethanol to be produced by 2022 (36 billion gallons_. That's roughly five times more ethanol than is currently produced. And it takes a lot of natural gas to produce that ethanol. In the U.S., corn is the largest source of ethanol. To grow corn, it takes a lot of fertilizer - about 22 million tons of fertilizer is consumed every year. The price of fertilizer is 90% dependent on the price of natural gas. On top of that, ethanol plants are powered by natural gas.
- Billionaire investor and oil tycool T. Boone Pickens, will propose to government that they give buyers of natural gas powered trucks a $70000 tax credit for the next three years. Replacing foreign oil with natural gas as a transportation fuel is a cornerstone of the "Pickens Plan,". An oil-alternative energy policy proposal the businessman has been promoting with a multimillion-dollar advertising campaign since July. With his plan, Pickens emphasizes that the Mideast could be "clear out of the picture" in 10 years. Pickens' plan would generate energy from natural gas and wind. Although he admits that economically natural gas is much more appealing as prices stay low.
- The volumes of gas in storage vary every year. During warm winters we consume less, for example, and during cold winters, more. When it's really hot, you use a lot of gas to generate electricity for air conditioning.
- Feb 2009 analyst comments on supply... "We believe there could be further downside to inventory estimates based on the current U.S. natural gas glut,". "We expect gas storage numbers to show weak year-over-year comparisons starting in March
Feb 11th News Release Excerpts from Paramount Energy Trust (PET) - they released 2008 year-end reserves, confirmed its February, 2009, distribution and updated its natural gas price management positions.
February distribution of $0.07
44% of 2009 production is hedged between $7 and $8 / GJ
Average AECO forward price for March through December, 2009, as at Feb. 10, 2009, is $5.35 per gigajoule. Calculated using 194 million cubic feet per day and includes actual and gas-over-bitumen deemed projected production volumes.
At current AECO forward prices of $5.35 per gigajoule for 2009, the trust's current monthly distribution level and capital expenditure program can be financed completely through funds flow. Incorporating PET's current hedging portfolio and forward natural gas prices into the trust's production, operations and funds flow projections, the current level of distribution represents a payout ratio of approximately 46 per cent for 2009. PET reviews distributions on a monthly basis. The trust continues to focus on what it believes is a sustainable distribution model that balances short-term cash returns to its unitholders and long-term value creation through capital reinvestment. PET reviews distributions on a monthly basis. Future distributions are subject to change as dictated by commodity price markets, operations and future business development opportunities.
Including changes in future development capital, PET realized finding, development and acquisition costs of $2.50 per million cubic feet equivalent
The trust's reserve to production ratio (reserve life index) decreased slightly to 7.5 years on a proved and probable reserves basis (4.5 years on a proved reserves basis) at year-end 2008, as compared with 7.6 years (4.7 years on a proved basis) in 2007.
PET's net asset value at year-end 2008 was $10.64 per trust unit discounted at 5 per cent compared with $11.41 per trust unit at Dec. 31, 2007, while the trust distributed $1.20 per trust unit to unitholders in 2008.