February 11, 2011 / 8:00 PM / 9 years ago

Analysis: Billionaires' bet on gas; brilliant or backfire?

HOUSTON (Reuters) - Some of the savviest U.S. investors — Carl Icahn, Wilbur Ross and T. Boone Pickens — are placing big bets on natural gas companies, a move that may backfire if bleak forecasts for the fuel play out.

The price of natural gas has risen about 20 percent from October lows, aided by wintry weather in populous areas like the U.S. Northeast. But heavy supplies remain, leaving some to ponder whether the market actually hit its low and whether companies with profits linked to the fuel are a sound investment.

“These guys are likely in it for the long term, just like the big oil companies,” Michael Kay, an oil analyst with Standard and Poor’s, said. “They probably see the market having reached a bottom, but inventories are still huge so you have to wonder.”

Icahn in December more than doubled his stake in Chesapeake Energy Corp, the second-largest producer of natural gas in the United States behind Exxon Mobil Corp.

Pickens is backing a buyout led by EXCO Resources Inc Chief Executive Doug Miller, who is pursuing a $4 billion management-led buyout of the gas producer.

Ross has steadily raised his stake in EXCO to nearly 10 percent and is considering joining the buyout as well.

More cold weather could sharply reduce the amount of gas in storage throughout the remaining winter months. But inventories are expected to build quickly in the second and third quarters as supply continues to outstrip demand, a factor that will likely push prices lower, analysts at Ticonderoga Securities forecast.

The prolonged weak natural gas prices, which have sent many U.S. energy companies scurrying to shift capital to oil exploration, have also inspired other private equity firms to bulk up on natural gas exposure.

“It’s hard to believe you are going to get the kind of returns they normally do with public equity,” Ray Deacon, an energy analyst at Pritchard Capital Partners, said. “But I guess public equity is very liquid compared to private equity.”

ICAHNIC

Shares of Chesapeake have jumped more than 30 percent since Icahn said the stock was undervalued on December 17, as other investors followed the billionaire’s lead. Chesapeake is chasing more oil production and has its 2012 gas production hedged, but its vast exposure to gas is undeniable.

“Icahn is playing into his investment approach with Chesapeake and betting on a long-term gas recovery,” Mark Hanson, an analyst with Morningstar, said.

“He might also be leaning on (Chesapeake’s) management a little more heavily to fast-track some of the value in their portfolio, but they are still weighted heavily toward gas,” he said.

Perhaps at Icahn’s prodding, Chesapeake recently promised shareholders it would stop spending billions to buy acreage and cut its debt. On Monday the company announced it plans to sell gas assets in the Fayetteville Shale in Arkansas, news that sent the company’s stock 7 percent higher that day.

Tudor Pickering Holt & Co raised its rating on Chesapeake to “buy” from “accumulate” on Monday, citing the stock’s potential and management’s recent steps to address its bulging debt.

Even so, a Tudor Pickering analysis in January measuring return and other factors showed Chesapeake among the bottom five in a list of 37 oil and gas companies the firm follows, showing negative cash margins and a single-digit return on capital employed for the year 2011.

Icahn did not respond to a call seeking comment on his investment in the U.S. gas company, and Chesapeake declined to comment on its relationship with the investor.

MARCELLUS PLAY?

Pickens, a Texas oilman and longtime cheerleader for natural gas, declined through a spokesman to comment on his interest in EXCO, citing U.S. Securities and Exchange Commission restrictions.

Ross could also not be reached to discuss his $387 million investment in the company, but analysts speculated that his stake in EXCO might be a way to participate in the buyout in a cheaper manner.

EXCO, like most other U.S. exploration and production companies, has invested in shale fields like the Marcellus and the Haynesville. Those fields contain so much gas — some say shale holds more than 100 years’ supply — that it has tipped the supply and demand balance in North America and hurt prices.

But if EXCO’s plans to develop its shale assets in those fields pan out, its production and proved reserves are set to more than double, Eric Chenoweth, an analyst with Morningstar, said.

The management-proposed buyout likely reflects a view of the business’s long-term potential rather than the short-term negative outlook reflected in current natural gas prices, analysts said.

Others are not so bullish on the outlook for gas.

“We’re drowning in gas,” said a hedge fund manager who asked not to be identified because he has had dealings with the billionaire investors. “Wall Street has a very romantic notion about the natural gas business, but in reality it is a very tough business.”

Reporting by Anna Driver in Houston; Editing by Gary Hill

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