Look out for natural gas Monday

07/31/2009 6:00 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Last week it was oil companies reporting their earnings numbers.

Monday investors get a big dose of numbers from natural companies.

The earnings aren't likely to be pretty although since many producers wrote down billions in assets last quarter--Chesapeake Energy (CHK), for example, wrote down $6 billion in assets--the numbers won't stun investors this time around.

The big issue for natural gas stocks--and for the shares of coal producers who compete with them--is when companies will start cutting production so that supply can fall closer to demand.

Natural gas prices fell another 2.4% Friday, July 31, under a double dose of bad news. Domestic natural gas producers Chesapeake Energy (CHK) and Southwestern Energy (SWN) reported big increases in second quarter production of 4% and and 65%, respectively. And the U.S. government announced that stock piles of natural gas were now 18.8% above the average level for the last five years. That's especially bad news since we're in the summer cooling season that usally results in a draw-down of gas stockpiles as utilities burn more natural to run gas-powered peaking turbines to meet the demand for electricity for air conditioning.

Three things to watch for:

First, are any natural gas companies running out of cash? Natural gas contracts for September delivery settled at $3.66 on Friday. At their peak in June 2008 contracts with similar duration were priced at $13.61. Know what that kind of price drop does to a company's cash flow? One of the reasons that gas companies have been reluctant to cut production is that pumping gas, even at low prices, does provide some cash to cover interest payments on debt.

Second, are any natural gas companies finally cutting production? Southwestern
Energy said it would cut third quarter production because of pipeline maintence. That's a step in the right direction but a drop in the bucket. It's hard to see how natural gas prices can recover in the short-term (six months) unless more companies shut wells.

Third, pay close attention to who hedged production and at what price. Companies that were lucky or smart hedged major percentages of  production at $5 or so are in relatively good shape in comparison to companies selling at current market prices. Of course, hedges don't last forever. What hedges look like now and going forward will tell investors a lot about company cash flows over the coming quarters.

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