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Wednesday, April 10, 2013

Profit From These Two Undervalued Marcellus Drillers

Marcellus Shale Gas Well
Marcellus Shale Gas Well (Photo credit: wcn247)
By Investment U

Chicago, Apr.10, free portfolios .- Roughly 150 miles west of where I'm sitting in northeast Pennsylvania is the top-producing natural gas formation in the United States. Hats off to the Marcellus.

A recent report issued by research company IHS claims gas production from the Marcellus shale formation is now 7.4 billion cubic feet per day (bcf/d). The Marcellus surpassed the Haynesville formation to garner its position as the country's highest producer.

But the best days are still ahead for the Marcellus. Marcellus shale output could reach 21 bcf/d by 2020.

In a moment, I'm going to tell you about two undervalued natural gas producers working in the Marcellus region that stand to make a killing from this upcoming Marcellus natural gas boom.

But first... a question.

What have most investors failed to realize about the Marcellus? The answer may surprise you: Even with drilling slowing, production is up.

That's what makes the two companies detailed below so undervalued. Let's take a behind-the-scenes look at what's happening.

Marcellus Gas Drilling Plummets... But Production Soars

With natural gas trading for an average of just $2 per mcf in 2012, drilling activity slowed. The number of rigs working in the Marcellus region dropped 33%. The end result? Only 1,365 gas wells were drilled in 2012. This represents a 30% decline from the prior year.

Take a look at this graph below from the Energy Information Administration.
Note that even though the number of "starts" dropped significantly, natural gas production shot up from 3.6 bcf/d in 2011 to 6.1 bcf/d in 2012. How is that possible? The newer wells were the beneficiaries of improved well fracking techniques, longer horizontal laterals and more fracking stages per length.

Interestingly, the number of drilling permits issued in 2012 fell only 5% from the previous year. This indicates companies have future plans to tap into this lucrative gas play. They're simply waiting for prices to rise.

Two Undervalued Marcellus Players

As part of its study, IHS appraised the net worth of Stone Energy Corporation (NYSE: SGY) and Southwestern Energy Company (NYSE: SWN). It believes both currently trade at sharp discounts to their peers.

I concur.

The reason is simple. U.S. natural gas is trading at the lowest price in the world. Its price must rise. In addition, fracking technology improvements will increase the value of both companies' developed, proven reserves.

Therefore, the Marcellus acreage of both companies is currently quite undervalued. With that idea in mind, it's not surprising they are shifting much of their 2013 capital budgets to the Marcellus.

Stone has 55 producing wells in the region - 35 of them produce over 50 million cubic feet per day - and it has more than 200 remaining drill locations in the Marcellus.

Best of all, Stone can generate attractive returns even with natural gas priced 50% below today's prices. Why? The company has increased its horizontal well lateral lengths by 50% to over 5,100 feet. In addition, frack stages have been increased from 10 to 16 per lateral.

Southwestern is also focused on improving its bottom line.

IHS says Southwestern has 1,100 drilling locations that are profitable when natural gas sells below $3 per mcf. As these wells will benefit from the latest fracking technology, the company's 2013 drilling plans will result in significant upside for shareholders.

Investors who want to make a value-based play on the unloved natural gas sector should consider a position in either of the two companies mentioned above.

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