Tuesday, July 12, 2011

"Merger Mania Returns to Natural Gas"

You've probably noticed that, except for a post on the volatility index yesterday, we haven't been tossing out many long ideas. The method to the madness? The old rule of thumb was that something like 75% of all stocks will rise or fall together and with even tighter correlations brought on by ETF bundling it might be over 90%.

Half the battle is getting the direction right. After that, you grab your instrument from the toolbox, leverage it as much as you and/or your banker are comfortable with and review your risk management protocols.

A week ago we put together a post showing the similarities between the five day, 5 1/2% move in the S&P, the takeoff of the market off the March 9, 2009 lows and the August 12, 1982 start of the 18 year bull market. I then pulled the rug out from any hopeful longs:
The problem is, I don't believe the picture the tape is telling.
Bucking the tape can be hazardous to your wealth but there are times when it is the right call. The jury's still out but sometime today we should hit a 38.2% retracement of the runup which might provide some opportunity on the long side. Here's one area to look at, from Money Morning Australia:
...We are witnessing a rapid acceleration of M&A in the United States. Unlike earlier waves of M&A activity, however, this is not primarily about extraction. The moves are in the support and transport sectors.

This is to be expected - for one fundamental reason: The volume of shale gas coming on the market is staggering. This year, North American producers (U.S. and Canada) could easily increase gas volume by more than 30%... in a single year!

Of course, dumping such volume on the market would cause a dramatic shift in the balance of supply and demand, with prices plummeting as a result.

In this environment, efficiency of operations may still refer to drilling per se. But these days, the ability of companies to realize profits, with the prospects of considerable available volume, depends on consolidating throughout the upstream-downstream sequence - not just in the fields.

Therefore, companies that control storage, processing, and transport facilities are primary takeover targets. And early identification of these likely targets can make for very profitable moves by average investors. More on that in a moment...

Probably the most prized asset class for acquisition is pipelines. The pipeline network in the United States and Canada is more than a venue for the transportation of gas.

The absolute majority of pipeline capacity is actually used for storage of excess volume. As a result, pipelines provide the main balancing act for a market that can easily become oversupplied.

Many of the companies of interest are diversified - made up of gathering, processing, truck, and retail distribution pipeline networks, as well as field operations.

Yet, if there is one conclusion emerging from what will be an increasing M&A feeding frenzy in natural gas, it is this: Operational efficiency requirements are moving acquisition strategies further from the field itself.
The midstream (gathering, processing, and throughput) is the emphasis now.

Some of these are privately held companies, so the retail investor has no access. But others are traded and have already experienced some consolidation.

The key to selecting the most likely profit moves is regional. Larger companies, utilizing an M&A plan to maximize the efficiency of their field operations, will need to acquire the assets that reduce the cost per volume of extraction. These certainly include pipeline, storage, and related facilities....