Southwestern Energy (NYSE: SWN PT $3.96)
This week’s topic is a continuation of the natural gas market with an analysis on Southwestern Energy (NYSE: SWN $4.98). Southwestern Energy is a pureplay natural gas E&P company based in Houston, Texas with assets across the Appalachia and Haynesville/Bossier region. Through their acquisition of GEPH merger, Southwestern acquired assets in the Haynesville and Bossier shale for an asset value of $1,783mm and $59mm, respectively. Though drilling costs in the Haynesville region are relatively higher than the Appalachia region by ~$1,100/lateral foot, production in this region once completed is relatively cheaper by ~$0.19/mcf. Drilling and production costs aside, this strategic acquisition places SWN at the heart of the LNG boom and allows easy access to the Gulf Coast where the majority of US LNG terminals reside. SWN currently produces 1.5bcf/d for LNG export, and, with future capacity expansions in the coming years, can see this number increase to 1.8-2bcf/d by 2025.
SWN shares currently trade at a TTM EV/EBITDA of 1.21x, well below the market; however, this may be a value trap as production through 2023 will remain flat at a much lower natural gas strip price of sub-$3.00/mcf, leading me to believe that shares should be priced at $3.96/share at my forward EBITDA projection of $2,177mm, holding all else equal.
There are various factors that can change these projections, most specifically geopolitical risk, which I will get more into below. Aside from this, I believe management is navigating this climate properly by right sizing production for the year and remaining prudent to their capital structure objectives. There are some challenges to management’s fundamental initiatives, however. With a more depleted cash balance of $3mm and a soft natural gas market, reducing debt and expanding operations in the Haynesville/Bossier region may need to be postponed until natural gas prices recover from this downcycle.
Since the oil bust of 2020, energy producers have been very vocal on maintaining flat/slow growing production, limiting capital investment to mostly maintenance, and maximizing shareholder value through free cash flow generation. SWN management is doing just that by actively extinguishing debt, initiating a share buyback program of $1b in FY22, and right sizing assets and developing their high-quality assets. Though SWN has not paid out a dividend in the last two decades, there might be some consideration for a dividend or a special dividend if/when the natural gas market stabilizes.
Management does expect the demand for natural gas in the US to increase by 10Bcf by 2025 without considering the demand overseas. Reviewing my notes on energy transmission, this figure may be a conservative figure as more capacity is being built out to replace coal and back up renewable resources.
The EIA reported 5/31/23 that natural gas production in March 2023 increased by 7.2% Y/Y to 102.3Bcf/d, the highest monthly production print since the EIA began reporting in 1973. Despite the suppressed prices, residential, commercial, and electric power utilities deliveries were the highest in 4 years (since the EIA began tracking for electric power utilities).
There is a major factor you don’t hear around the street all too often and that revolves around the EU’s energy policy. Germany shut down its last remaining nuclear power plants in April of this year, as reported by CNBC. Germany shuts down last nuclear power plants, some scientists aghast (cnbc.com) Despite this shift in power sentiment, the bloc is being proactive in building out its renewable capacity, with a new 100MWh battery storage facility that will be able to support 300,000 homes for a total of two hours. Europe is saved.
The EU will inevitably run into similar problems faced in 2022 as natural gas still supports 23.7% of the bloc’s energy mix and leadership’s altruistic faith in renewables may be more burdensome on their citizens than they realize.
The strategic gas reserves for the EU has significantly depleted to 56%, or 65.52Bcm since the scare of 2022. It’s challenging to state what the EU will do going forward, whether they’ll allow the reserves to dip sub-30% again, but I would presume they’d take a more prudent approach and learn from their mistakes. Unless the UKR/RUS war is resolved and the EU seizes Russia’s gas assets for any reason, I’d expect the necessity to import more LNG will be at the forefront this summer going into the cooling season.
Reuters had previously reported that the EU has storage capacity of 117Bcm (billion cubic meters) of natural gas, or roughly 1/5th of its annual consumption. According to the European Council, the EU imports 87% of their natural gas capacity through various contracts with Algeria, the US, Qatar, and other countries with the balance coming from Norway. Doing some math here, the EU consumes roughly 585Bcm of natural gas annually to sustain energy demand pre-nuclear plant retirements. This would suggest the EU will need to import more than 509Bcm this year to maintain living standards and manufacturing levels. Depending on policy surrounding coal capacity, this figure may be low. The EU is estimated to utilize 471Mt of coal through 2023, slightly above the estimated consumption of the US.
The point I’m drawing across is that the EU has been more than aggressive when it comes to transitioning out of “dirty” energy sources in favor of renewables without fully comprehending, or possibly blatantly ignoring, the consequences of their actions. The challenge that seems to be overlooked today is the drastic measures taken by governments, industry, and citizens to preserve natural gas in anticipation of a harsh winter. Measures included cut production, limited operating hours for storefronts and retail display lighting, manufacturing reductions or cycling, thermostat minimum/maximum utilization. Citizens in the European bloc were essentially living as if they were in a 3rd world country. Unless that’s going to remain the norm, demand for natural gas is very likely to improve as we work through the duration of the year. For Southwestern Energy, this should provide support for natural gas sales and can potentially lead to a premium over the Henry Hub quoted prices.
Though 2023 will be a challenging year for natural gas producers, the future looks very fruitful as new natural gas-fired power plant capacity is being built out across North America and Europe. The natural gas scare in the EU in 2022 isn’t going to be a onetime occurrence if leadership isn’t proactive in rightsizing their energy capacity. Though it may take a few years for foreign leaders to realize this and get their heads out of their net-zero emission asses, the demand will be there and natural gas may finally be priced for growth.
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