Natural Gas Prices Are Coming Down. What to Expect for Energy Stocks.

The good news is that energy prices are coming down for households. The bad news is that energy stocks are feeling the pain.

The best-performing sector in the stock market last year is finding itself under pressure in 2023 because natural-gas prices have tumbled more than 60% from their 52-week high thanks to a warmer-than-expected winter. While households may rejoice at spending less for heat, energy investors are less sanguine. And those who are both consumers and investors are left scratching their heads as to whether to celebrate or worry.

Lower gas prices are a boon to household budgets, which have been constrained by inflation running at four-decade highs. The saving grace for investment portfolios has been energy stocks. While the S&P 500 fell 19% in 2022—its worst showing since 2008—the Energy Select Sector SPDR Fund (ticker: XLE) gained 58%.

But now, in what is forecast to be a challenging year for equities, Wall Street is also getting nervous about the outlook for natural gas. Even though the new year is just a few days old, the price of natural gas is down 17% to $3.72 per million British thermal units. Stocks such as EQT (EQT), Coterra Energy (CTRA) and Antero Resources (AR) have fallen by percentages in the mid-to-high single digits. And that may just be the beginning.

"The warmer-than-expected winter pulled forward the expected decline in natural gas price. Stocks could fall an additional 20% to 30% until they find a bottom," Matt Portillo, head of research at Tudor, Pickering, Holt, told Barron's.

Portillo was early in noting the headwinds natural gas faced, telling Barron's in November that U.S. production outstrips demand by roughly three billion cubic feet a day. And the U.S. is limited in what it can do with that gas. Even though Europe needs gas because Russia has cut off supplies in response to the European Union's support for Ukraine, there isn't enough infrastructure in place for the U.S. to fully export its surplus.

For now, Wall Street expects more volatility in natural-gas prices as the rules of supply and demand play out this year. But patient investors can look forward to more attractive valuations in the second half of this year. Analysts appear more optimistic about the natural gas business in late 2024 and 2025.

"We expect the coming volatility to present a better entry point than is currently available and expect recent volatility to persist through the winter, at which point eyes will turn to the build for next winter," Paul Diamond, analyst at Citigroup, wrote in a note Tuesday discussing the longer-term fundamental outlook for natural gas.

Even so, given the short-term picture, Diamond reiterated recent Citigroup downgrades of natural-gas oriented exploration and production companies. Comstock Resources (CRK) and Coterra remain Sells, while EQT and Southwestern Energy (SWN) are still rated Neutral, he wrote.

Those who want exposure to the space now could look to Chesapeake Energy (CHK), which is rated the equivalent of Buy by 80% of analysts surveyed by FactSet. The average price target is $142.79, implying a gain of 68% from recent trading levels.

Portillo considers it a "defensive Buy." He noted that while the company faces the same problems as its peers, the proceeds of its expected sale of its Eagle Ford Shale assets in the first half of the year could be used for share repurchases.

With stocks tumbling, buybacks may be a good use of capital.