EQT is an insurance company

The relevance of natural gas for baseload power burn will diminish as the renewables expansion progresses. This alters the nature of gas producers. They need and will embrace this transition.

Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.

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TLDR Summary

• Energy assets in general and natural gas assets in particular remain out of investor favor. Investors shun them, presumably due to recession fears. And on average, natural gas prices remain dangerously close to the industry’s production breakeven, which is possibly toxic for highly leveraged producers. I believe it is helpful to look at the natural gas sector from a different angle.

• EQT 0.00%↑ is the largest natural gas pure play out there which makes them an insightful case study. Their natural gas production assets effectively grant them a call option on extracting natural gas from the ground. The exercise price on that call option is equal to their production costs of about $2/cf. Given that domestic spot natural gas prices are on average hovering at exactly that level, this call option appears uninteresting from an investor perspective.

• However, natural gas is effectively becoming an insurance business in a world that is more and more dominated by renewable energy sources. It’s the primary energy source to buffer the production swings in wind and solar and the consumption swings due to weather, seasonality and macro cyclicality.

• EQT’s natural long call option enables them to sell insurance (i.e. sell calls) to consumers that need or want to protect themselves against price surges. With more renewables on the grid, the risk for such a surge increases. That makes the insurance policy more valuable and should enable EQT to earn more.

• EQT sells about 60% of their production forward through derivatives at prices north of $3 which is a hefty premium on average natural gas spot prices and a healthy premium on their breakeven. Over the last twelve months, their production costs have roughly equaled Henry Hub spot. But their revenues have been $0.46/cf higher.

• For these reasons, I don’t necessarily view EQT as a bet on rising gas prices, at least not primarily. Instead, I view this stock as a bet on management’s ability to embrace their role as an insurance carrier to the US energy economy and play the futures term structure to their advantage, regardless of where the gas price is.

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