4/21/11: Natural Gas at Home and Abroad

Although Wildcatters Portfolio holding Range Resources Corp (NYSE: RRC) has performed well since we downgraded the stock to a hold, overly eager investors will lose interest once the market comes to grips with the weak near-term outlook for natural gas prices. Shares of Range Resources would be particularly vulnerable if natural gas prices decline in spring. That’s not to suggest the company is poorly run. Range Resources is the preeminent producer in the Marcellus Shale, and management continues to divest noncore assets to fund its drilling activity in the region.

In addition to the Range Resources’ ongoing efforts to lower drilling costs, the company also benefits from the liquids-rich areas of the Marcellus. Prices for natural gas liquids (NGL) have remained robust, thanks to rising demand from the petrochemicals industry.

Westlake Chemical Corp (NYSE: WLK) is the latest major chemicals producer to announce efforts to boost its output of ethylene, a key building block in many plastics. In a remarkable change of fortune, producing many basic chemicals in the US is now cheaper than producing the same chemicals in the Middle East.

Nevertheless, shares of Range Resources are vulnerable to a correction in natural gas prices. Sell Range Resources Corp and book a gain of roughly 28 percent from our recommendation in late 2009.

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Five years ago, Oil Search (ASX: OSH, OTC: OISHY) produced more than 10 million barrels of oil equivalent; at the end of 2010, its output had declined by roughly 25 percent–largely because of declining pressure in its mature wells.

The company has taken steps to offset that decline, drilling new wells in these older fields that target untapped pockets of oil. For example, Oil Search has sunk wells in Agogo, a smaller satellite field that’s adjacent to Kutubu, the firm’s largest play. One of these wells struck oil and now produces 1,500 to 2,000 barrels per day.

Fields such as Agogo should help to offset declines in Oil Search’s mature fields over the next few years. Management expects the company’s oil production to hover between 6.2 and 6.7 million barrels per year range in 2011-13. For comparison, the firm produced about 6.768 million barrels of crude oil 2010.

Rising oil prices have helped the the company’s bottom line and offset recent output declines. In 2010, for example, Oil Search’s output declined roughly 6 percent from the prior year, but revenue surged 14 percent and earnings before interest and taxation jumped 27 percent.

If all Oil Search had to offer was declining output from a handful of aging oilfields, the stock wouldn’t warrant a second look. But the company is in the midst of a transformation that should quadruple its production. The main driver of this is the Papua New Guinea LNG (PNG LNG) project.

Oil Search’s American depositary receipts (ADR) trade thinly–only a few thousand shares change hands on most days. Investors should buy the local shares on the Australian stock exchange to ensure sufficient liquidity. Buying shares in Australia used to be a pain for US-based investors, but many brokers will now handle such transactions and some will handle the trades online. Investors who opt for the ADRs should use a limit order to avoid overpaying for the stock.

Oil Search, a new addition the Gushers Portfolio, rates a buy under AUD8; the company’s ADR, which represents 10 local shares, rate a buy up to USD85.

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