Exploring Upstream Natural Gas Valuations: A Year of Significant Changes

The electron precedes the molecule or so the saying goes. Well, that is not really an axiom to my knowledge, but it does seem to fit. Amid the uncertainty in oil markets, for the past year or so, optimism and valuation metrics for natural gas producers have steadily been rising. According to data from Mercer Capital’s quarterly Value Focus: Exploration and Production, reports whereas a year ago show cash flow multiples (or sometimes referred to as EBITDAX in the oil and gas industry) for both oil and gas producers tended to centralize around four (4) to five (5) times, lately, publicly traded gas producers have EBITDAX multiples in the low- to mid-teens, while predominately oil producing companies’ multiples have dropped.

Oil & Gas EV/EBITDAX Multiples Q1 2024-Q1 2025

Mercer Capital

This has been a dramatic change in the past year compared to the industry’s history. While onshore producers of oil and gas have many similar operational and economic traits, such as the shrinking inventory of top tier wells, this decoupling is representative of a fundamentally different outlook for the future of each commodity.

Demand: Record Gas Demand Is Headed For More

Gas has a bright future as a commodity as one of its key consumption outlets, electricity, is at an all-time high and is growing. The EIA reported a few weeks ago that after decades of relatively flat electricity demand, the desire for more current, volts, and ohms will be required for commercial growth, onshoring of manufacturing, and, of course, data centers that fuel A.I. Much of this is anticipated to be in other forms such as solar, but natural gas will be a part of this equation with 4.4 gigawatts of new natural gas-fired capacity to be built in 2025.

U.S. Electricity Consumption 1990-2026

EIA

This is not short term either. The EIA also estimates electricity demand to grow by around 50% by 2040 in its latest Annual Energy Outlook. This should take some time to translate into measurable gas demand and potential price increases, which partially explains why EBITDAX multiples for companies such as Comstock Resources are relatively high. East Daley Analytics, an energy infrastructure consultant, claims that the gas market will operate in a cautious holding pattern for the time being. However, when LNG expansion terminals ramp up and electricity demand really picks up, the markets will tighten, especially in pricing hubs connected to export markets. LNG growth remains a bulwark for future natural gas demand growth from around the world, not just domestically.

Market participants anticipate this as well. In the latest Dallas Fed Energy Survey projections suggest that gas prices, although not expected to get to $5.oo per mcf like some executives would prefer, are headed towards $4.00 per mcf. Perhaps that is fueled by larger geopolitical developments such as the EU proposing a blanket ban on Russian natural gas.

What do you expect Henry Hub natural gas prices to be in six months, one year, two years and five … More years?

Federal Reserve Bank of Dallas; Energy Information System

Infrastructure Activity Ramping Up

These dynamics are driving activity within multiple related segments of the marketplace. Just this week Hart Energy reported that the long embattled Constitution Pipeline in the Northeast United States is back on the table for Williams Companies. That’s right, Williams is attempting to re-petition federal and state authorities for the Northeast Supply Enhancement project after Governor Kathy Hochul agreed to show openness to the construction of natural gas infrastructure in New York. Williams is also pursuing growth in its Transco system as well. Plus, in the past 45 days the Calcasieu Pass, Louisiana LNG facility launched commercial operations. That is just 68 months after its August 2019 final investment decision, a relatively quick turnaround for a project that large.

In addition, the electrical utility and generation space has ramped up merger and acquisition activity. Blackstone is acquiring TXNM Energy, NRG Energy is acquiring generation assets from LS Power, and Vistra Corp. is buying 2,557 megawatts of natural gas generation assets from Lotus Infrastructure Partners for around seven (7) times EBITDA. In the last year where merger and acquisition activity has been slow, this is an optimistic indication of more building and buying to come.

Supply: Good Inventory Shrinking While Efficiency Wanes

Even though the U.S. has a lot more gas reserves relative to oil, there are only so many low cost wells that are profitable at gas prices below say $3.00 per mcf. Although, technology, particularly fracking, has been revolutionizing the industry, it is now around 20 years in. As my fellow Forbes columnist, Ian Dexter Palmer showed last week, fracks are long, complex, and use a lot of water and resources. Even so, the best locations are dwindling, and it will get more and more difficult to keep capital efficiency high on a per well basis.

One investor group, Kimmeridge, put out a paper on this very issue a few weeks ago. The data is fascinating. While oriented towards analyzing remaining oil inventory, it covers gas too, and it demonstrates that core shale acreage in the United States is being exhausted based on estimated ultimate recovery of resources per foot of rock. In addition, the operating costs to find and develop oil and gas as compared to the operating cash flow, what Kimmeridge refers to as the “recycle ratio,” started shrinking a few years ago and are projected to continue to shrink. This makes drilling more economically inefficient and thus incentivizes operators to wait to drill until prices make it worthwhile.

There are some formations that have more runway than others, but overall, it will become increasingly difficult for an operator to drill a relatively inexpensive well. Kimmeridge mentions the Marcellus Shale as one field with a good amount of high-quality acreage remaining, but that is more of an exception than the rule according to the paper. Blending that with the increasing demand I mentioned earlier, it is a recipe for higher natural gas prices going forward.

Add all of this up and it seems investors see cash flows picking up significantly in the future for upstream natural gas producers. It shows in robust EBITDAX multiples that investors in Expand Energy, EQT, Comstock Resources, Range Resources, Antero Resources, and the like appear to be eagerly looking forward to what comes next.