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Good times are ahead for natural gas explorers as the commodity’s pricing environment is anticipated to improve further in the near term. The expectation is fueled not only by a reduced inventory, but also by greater demand as utilities shift from coal-fired to natural gas plants for electricity generation in the face of summer temperatures that have been steadily rising over the years.

Supply Concerns

A cold snap in early 2014 boosted the demand for natural gas as both residential and commercial consumers sought space heating and lowered the storage level. As per the Energy Information Administration (EIA), which provides official energy statistics from the U.S. Government, natural gas held in underground storage is currently 31.0% below the 5-year average stockpile.

Demand Growth

Move Toward Nat Gas fired Plant: With an aim to combat climate change, the United States Environmental Protection Agency recently came up with a plan to reduce carbon emission from power plants by 30% from the 2005 level by 2030. We all know that power plants fueled by coal emit the highest level of carbon dioxide. Hence, we expect the U.S. to gradually shift focus to natural gas fired plants and retire the coal units.

In fact, the country started witnessing this shift last year. As per EIA, of more than 13,500 megawatts (MW) power capacity added in the U.S. last year, natural gas comprised more than 50%.

Rising Summer Temperatures: Over the last few decades, U.S. summer temperatures have been rising, mainly due to the emission of heat-trapping greenhouse gases. This, in turn, has been favoring the price of natural gas in summer as the demand for space cooling is on the rise.

The Result: Natural Gas Prices Rise

Spot natural gas prices have recovered strongly from a 10-year low of $1.82 per million Btu (MMBtu) during late Apr 2012 to the current level of around $4.35 per MMBtu. While the odd pullback to $3.50 cannot be ruled out, strong fundamentals point to higher natural gas prices in the near-to-medium term.

Winning Bets

The positive demand supply equation presents the natural gas upstream companies with enough opportunities going forward. We present three stocks which possess the potential to grow in such an environment, each of which also has a good Zacks rank.

QEP Resources Inc. (QEP - Analyst Report)

The Denver, CO-based company is a leading independent energy company mainly engaged in the exploration, development and production of natural gas.QEP Resources’ operations are focused on the Northern Region (primarily in the Rockies and the Williston Basin) and the Southern Region (primarily Oklahoma, the Texas Panhandle and Louisiana) of the U.S.

As of year-end 2013, QEP Resources had 4,061.9 billion cubic feet equivalent (Bcfe) in proved reserves (63% natural gas). Approximately 75% of this was located in the Northern Region, while 25% came from the Southern Region. QEP Resources’ output totaled 309.0 Bcfe in 2013, of which nearly 71% was natural gas.

The company currently sports a Zacks Rank #1 (Strong Buy) and has expected long term earnings growth of 15.0%.

Encana Corp. (ECA - Analyst Report)

Headquartered in Calgary, Alberta, Encana is a focused pure-play natural gas exploration and production company. It is the second largest gas producer in North America, and holds a highly competitive land and resource position in a number of the region's most promising shale and tight gas resource plays.

The company’s prolific gas resource plays include Coalbed methane (CBM) in central and southern Alberta, Bighorn Deep Basin in western Alberta, Cutbank Ridge and Greater Sierra in British Columbia, Jonah in Wyoming, Piceance in Colorado, the Barnett shale play in Fort Worth, and Bossier in east Texas.

As of year-end 2013, Encana had 10.0 trillion cubic feet equivalent (Tcfe) in proved reserves, of which roughly 86% was natural gas.

Apart from a Zacks Rank #1, Encana has expected earnings growth of 6.0%. It has a forward price-to-earnings ratio P/E of 14.07x, which is lower than the peer group’s average of 19.00x.

Ultra Petroleum Corp. (UPL - Analyst Report)

Based in Houston, TX, Ultra Petroleum is an independent energy firm primarily involved in the acquisition, development, exploration and production of natural gas properties. The company’s operations are focused on the Green River Basin of southwest Wyoming, mainly covering the Pinedale and the Jonah fields. Ultra Petroleum also holds impressive acreage in the north-central Pennsylvania area of the Appalachian Basin and the Uinta Basin in northeast Utah.

 As of year-end 2013, the company had 3.61 trillion cubic feet equivalent (Tcfe) in proved reserves, of which more than 94% was natural gas and about 53% was developed.

Ultra Petroleum holds a Zacks Rank #2 (Buy) and has an expected earnings growth of 13.55%. The P/E for the firm is 9.93x, also below the peer group average of 25.91x.

Bottom Line

Although the natural gas upstream companies are exposed to volatile gas prices, we still have enough reasons to believe that natural gas prices will favor the companies in the near term. Companies with a solid reserve base and good fundamentals are expected to cash in a better pricing environment and translate it to increased shareholder value.

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