Buying This Oil & Gas Stock With Multiple Ways To Win

In mid-May I attended Hart Energy’s SuperDug “the largest shale event of 2024” in Fort Worth. One of the main topics covered by multiple speakers was the growing power demand increasing the need for natural gas fired power plants. Oil was also on everybody’s mind. Especially the massive wave of M&A centered around the Permian Basin.

Coterra is an oil and gas play with good stand alone assets. However, I believe they will engage in M&A soon either being swallowed whole or parted off. They could also find themselves down to one core asset, most likely in the Delaware Basin of the Permian.

Based on the value of its assets and strength of their low leverage balance sheet, I believe the company is worth on a sum of the parts basis, at least double its current market cap. It is currently depressed due to low natural gas prices. While I wait for the future with Coterra, I can collect a 3% dividend.

If the company can return to around $2.8 billion in free cash flow that it achieved in 2022, at typical buyout around 10x fcf, the company is worth at least $28 billion against the current $20 billion. However, I think we are going to see a significant uptick in oil and gas prices in coming years for a number of reasons. If you believe that, then it becomes pretty easy to see the company being worth north of $40 billion on oil near $100/barrel and natural gas prices above the $6.64 per btu we saw in 2022.

Coterra Energy (CTRA) has been on my very short list since 2020 and I have had a starter position in it since late 2020. After hearing what I did in Fort Worth, I have increased my holding in anticipation of a monetization event. I rate Coterra a strong buy for investors who like the margin of safety that energy demand and good hard assets offer.

Growing Power Demand

AI data center and blockchain, as well as, electrification of transportation, industry and real estate are driving record demand for electric power.

Currently, blockchain, primarily Bitcoin mining, uses up to 2.3% of all U.S. electrical power according to the EIA.

Goldman Sachs laid out a case that data center energy demand will grow to at least 8% from 3% by 2030, more than doubling and possibly more than tripling.

Data Center Electricity Demand
Data Center Electricity Demand (Goldman Sachs, EIA)

EV energy demand is forecast to roughly triple by 2030 from 8 TWh to over 23 TWh as a base case. I’ll take the over on that for two reasons. First, EV tech is becoming more affordable. As prices converge for EVs and for plugin hybrids which are already close in price to gasoline cars, adoption will increase. Also, if oil becomes more expensive, as I now believe it will (I will cover that in another piece) that will also drive EV adoption as substitution occurs.

U.S. EV Energy Demand
U.S. EV Energy Demand (EIA)

Overall, power demand is at record pace now and is accelerating. This is following roughly a decade of no demand growth.

Electricity Demand Growth
Electricity Demand Growth (McKinsey, FT)

An AOTA, all-of-the-above, energy strategy is going to be required to provide the global energy demand that is developing. That will include natural gas.

Natural Gas Outlook

Natural gas supply has surged on Permian oil drilling which creates affiliated gas, the finishing of much DUC (drilled buy uncompleted) well inventory and a maxed out LNG export industry. This has driven a crash in natural gas prices likely to persist through summer.

The industry though is adjusting by committing less capital to drilling new wells in the short-term. Raymond James analyst Marshall Adkins provided this slide illustrating how hard natural gas activity is falling on the low prices.

Gas Rigs Down 38%
Gas Rigs Down 38% (Raymond James, Bloomberg)

Simply put, the price of natural gas isn’t high enough right now to justify drilling more natural gas. The futures market is telling us though that we should expect natural gas prices to head up by next year.

Currently, the strips are showing a range of natural gas prices in 2025 of $3mmcf to $5mmcf. That’s about double on average current prices and enough to increase capital commitments to new drilling by next spring (give or take).

In addition to the power demand discussed above, there are also multiple LNG export facilities coming online. According to Natural Gas Intelligence, there will be an increase of LNG export capacity by 76% in late 2024 into 2025. That will amount to over 5 billion cubic feet per day of natural gas exports.

Steve Pruett of the Independent Petroleum Association Of America provided this look at domestic natural gas including exports.

U.S. Natural Gas Production, Use, Exports
U.S. Natural Gas Production, Use, Exports (Steve Pruett Independent Petroleum Association Of America)

Despite the current negative narrative on EVs, sales for EVs and plug-in hybrids continues to have significantly higher growth than fossil fueled cars. I believe that electrification of transportation is understated in power demand from 2026 to 2030.

In addition, many industries are electrifying to reduce their carbon footprint. Indeed, we are seeing the fossil fuel start to electrify their own operations by using natural gas to generate electricity and then capture the carbon for the tax credits.

While solar is the runaway winner for electricity generation growth and brand new wind technologies that do not require massive turbines show promise, one way to look at their growth is that they are replacing coal.

Solar Replacing Coal
Solar Replacing Coal (Raymond James, EIA)

Another way to look at solar (and wind’s) growth is that combined they are barely meeting new total power demand, pre-EV adoption. So, regardless of how you look at it, there is a huge gap that natural gas has to fill for record breaking power demand growth. Ultimately, solar, wind and natural gas are the big power generation winners.

Solar, Wind, Gas Replace Coal
Solar, Wind, Gas Replace Coal (Raymond James, EIA)

Coterra’s Core Assets

Coterra (CTRA) was formed by the merger of Cabot and Cimarex a few years ago. Their website touts them as “flexible and built for the future.” Indeed, their flexibility has led them to slash natural gas capex in the face of low natural gas prices. They have pivoted to their oil rich and NGL assets.

Coterra has three major asset plays: Permian Basin, Marcellus Shale and Anadarko Basin.

  • Coterra has 296,000 acres the Permian’s western Delaware Basin which is primarily oil, but also has associated gas and some natural gas liquids. The acreage is largely in Tier 1 & 2 areas of Culberson County.
  • Anadarko has 182,000 net acres in the Woodford Shale and Meramec formations. Its production is split between oil, gas and natural gas liquids.
  • Marcellus Shale has 186,000 acres that is a very productive natural gas area. They have scaled down capex by 55% the past year to focus on oil while natural gas prices are low.
Coterra Commodity Splits & Assets
Coterra Commodity Splits & Assets (Coterra)

Considering The Permian

The Permian, as the last significantly growing U.S. oil basin, is still ignored by most investors. That yields some great investment opportunities for people who want to use one of two strategies:

  • Profit in the intermediate term from M&A.
  • Profit from holding for a very long time from free cash flow being returned to shareholders.

Indeed, Matador’s CEO and Founder Joe Foran discussed both M&A in the basin, as well as, saying “treat it like you’ll own it forever.”

In the past year there has been over $100 billion of mergers and acquisitions in 2023 the Permian. It has seen another $50 billion in 2024 so far. There will be more. That has led and is leading to significant concentration in the oil patch.

Here it is important to know that the mergers and acquisitions are largely happening to create larger acreage leaseholds for accommodating longer laterals. When I first visited the Williston Basin in 2012, the laterals were in the hundreds of feet. Today they are getting ready to make runs at 3-4 miles.

The longer laterals are to improve well efficiencies. In addition, it was widely discussed that oil supply growth in the Permian wouldn’t last another decade, with 5-7 years being a common estimate for when supply turned over in the Permian. Given that is the last growing basin, it is telling for U.S. oil supply in the 2030s.

I share this graphic courtesy and with permission from Matthew Bernstein at Rystad Energy whom I will be doing a future interview with.

Permian E&Ps With Recent M&A
Permian E&Ps With Recent M&A (Rystad Energy, Matthew Bernstein)

Coterra’s assets are in the Delaware Basin of the Permian. That part of the Permian is a harder play. Scale, expertise and deep pockets matter.

Coterra In The Permian
Coterra In The Permian (Coterra)

The bunching of the Culberson assets make that a potential play to keep. The Lea is ripe to be sold to an adjacent operator.

Coterra Probably Has M&A In Their Future

Coterra’s future M&A could come in three forms:

  • They could sell their Permian and Anadarko assets and become a Marcellus pure play. In this scenario, the old Cabot assets would be left standing.
  • Sell the whole company to a very large operator who then parts off what they don’t want. Several recent deals, including Occidental’s acquisition of CrownRock have taken this form where the acquirer spins off non-core assets.
  • Coterra could sell their Marcellus assets, where they just laid off a third of their workforce, and then buy assets in the Permian. That could then be an avenue to selling their Anadarko assets and becoming a Permian pure play before selling that too.

Here are some of their dance partners in Culberson County per

  • Apache Corp (APA) which always seems to be looking for ways to shuffle the cards. Coterra could acquire or sell acreage.
  • BPX (BP) which suggested at the conference they were looking to acquire in the Permian.
  • Chevron (CVX) which is always looking to acquire what the Justice Department will allow them to.
  • ConocoPhillips (COP) has sizeable Delaware holdings and it would make sense for them to strategically buy more. They might have DOJ constraints on anything large though.

What is interesting is that only 45 permits have been issued in Culberson so far this year. Diamondback Energy (FANG) alluded to this when they discussed their plans in the Permian. They suggested that they would wait to develop or divest the more difficult Delaware while focusing on the Midland.

I think the comment and the permit issuance is telling in that it means that Coterra is either going to become bigger in the area, as longer laterals are the happening already, or sell completely.

Devon Energy (DVN) is an interesting potential mate for Coterra as they have both Permian and Anadarko Woodford assets. If Devon were to be an acquirer, this could be a step toward another deal. In this merger, the Marcellus assets would be sold or potentially remain in the hands of a stripped down Coterra. That would leave Coterra very cash rich with a great natural gas asset.

In the Marcellus, EQT (EQT) with over a million acres, Chesapeake (CHK) with over 465,000 and Antero (AR) with over 400,000 acres all seem to be natural buyers for Coterra’s natural gas acreage. Again, that would strongly help Coterra’s already strong balance sheet and leave them more focused on oil.

Earlier in this piece I covered the heavy natural gas demand that everyone is now forecasting due to AI data centers, crypto mining and electrification of almost everything. So, that’s where I’ll circle back to in discussing the Marcellus assets.

I don’t know what management will decide long-term, but, the desire to either focus on the Marcellus or leave it altogether seems to be in play. The company is indeed flexible. They could simply sell their Lea and Anadarko assets to focus on their Marcellus acreage and Culberson County.

Wrapping Up The Coterra Investment Thesis

So, I’ve laid out the case for being at the bottom of what looks like the beginning of new bull market in natural gas developing. That should increase the value of the Marcellus assets as they are depressed on low gas prices.

I hinted at the value in the Permian given flattening U.S. oil production later this decade. There is a reason why there is a massive land grab in the Permian. It is the last place in the lower 48 states to have a growing oil basin in the face of flattening U.S. oil supply later this decade.

Ultimately, I am suggesting that oil and gas return and surpass 2022 prices in the next few years which would drive free cash flow for Coterra.

And, I’ve laid out a lot of scenarios for strategic transactions by Coterra.

In the end, so long as management can maximize the value of their assets and return cash to shareholders, I think they will be a big winner for us. To that, they have been very good at returning cash.

The company is committed to returning 50% or more of free cash flow to shareholders. There is $1.4 billion remaining on a share repurchase authorization. Their forward dividend yield is at 3% and has grown 23% an average the past 5 years. The dividend is variable, so, expect higher payments after a strategic sale or with rising oil and gas prices which I think is all but certain in coming years.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of CTRA, OXY either through stock ownership, options, or other derivatives.

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