Ospraie Killer XTO Bottoms, Stock Cheapest Since 2001

By Dan Lonkevich

Sept. 8 (Bloomberg) -- The worst may be over for the biggest U.S. natural-gas companies as colder weather and the cheapest valuations since the Sept. 11 terrorist attacks prove irresistible.

Investors bought a net $114 million of XTO Energy Inc. and Oklahoma City-based Chesapeake Energy Corp. as they fell in New York Stock Exchange trading, a record for the first week of September, according to data compiled by Bloomberg. B.J. Willingham, a hedge-fund manager who predicted oil's collapse in the 1980s, is purchasing XTO shares because the value of its stock and debt is about $2.75 per thousand cubic feet of reserves, the cheapest since 2001 compared with gas on the New York Mercantile Exchange.

``We could see a 20 percent increase in these stocks between now and the end of the year,'' said Willingham, who helps manage about $100 million at Moncrief Willingham Energy Advisers in Houston. ``The first whiff of cold weather and the shorts are going to head for the hills.''

Just a week ago, traders speculated the largest independent gas producers were nowhere near bottom because the Standard & Poor's GSCI commodity index was tumbling 26 percent and Hurricane Gustav had done almost no damage to oil and gas facilities in the Gulf of Mexico. XTO's 31 percent plunge in July, the biggest drop in a decade, forced Ospraie Management LLC to shut down its largest hedge fund last week after losses of 38 percent.

Winter Demand

Robert Goodof, who helps manage $25 billion at Loomis Sayles & Co. in Boston, says Chesapeake, the biggest producer in the industry, and Fort Worth, Texas-based XTO, the second- largest, are ``attractive at these levels.'' He expects a rebound as the onset of winter in the Northern Hemisphere lifts demand for gas, which heats 57 percent of U.S. homes, according to the American Petroleum Institute.

Nymex futures, which dropped 43 percent since June 30, rose 19 percent on average from Sept. 1 to Dec. 31 during the past five years, data compiled by Bloomberg show. Futures now show prices will increase 16 percent to $8.66 per million British thermal units by February.

Gas for delivery in January traded as high as $9 per million Btu last week, while October contracts sold for as little as $7.02, a 2008 low.

Before today, XTO dropped 29 percent since the end of June on the NYSE, while Chesapeake tumbled 33 percent, dragging the ratios of price to earnings to the lowest levels since March.

Stock Rally

XTO fell to about 12 times earnings, 20 percent below its average since the start of 2007, on Aug. 5. Chesapeake's ratio, at 14.7 times, was 15 percent below its average. Other gas producers, including Houston-based EOG Resources Inc. and Fort Worth-based Range Resources Corp., reached similar lows.

Analysts anticipate higher prices in the next 12 months. XTO will climb 56 percent, according to the average of price targets compiled by Bloomberg. Chesapeake will rally 79 percent, the estimates show.

XTO fell 28 cents to $48.32 at 10:30 a.m. in New York Stock Exchange composite trading, and Chesapeake dropped 44 cents to $43.90. Gas futures rose 1.8 percent to $7.58.

Earnings per share will jump at least 21 percent this year and 14 percent in 2009, the estimates show. Houston-based gas producer Petrohawk Energy Corp., which had its biggest decline in more than four years last week, will see its profit and share price more than double, according to the estimates.

Production Increases

Gas, which outperformed all commodities other than coal in this year's first half, tumbled as U.S. production rose toward the highest since 1973.

Net short positions, or bets that gas prices will drop, more than doubled since June to 161,076 contracts on Sept. 2, the most since reporting of the data began in 1993, according to the U.S. Commodity Futures Trading Commission in Washington.

Should prices decline, producers will cut output and face the prospect of getting paid less money for less gas, said Philip Weiss, an analyst at Argus Research in New York. Some producers may slow output when prices go below $6 or $7 per million British thermal units, he said.

XTO and other companies contributed to price declines by unlocking gas that was trapped in so-called shale formations from Texas to Pennsylvania. The deposits reduce reliance on the Gulf of Mexico, where 14 percent of America's gas is produced. Prices rose to an all-time high of $15.78 in December 2005, after Hurricanes Katrina and Rita idled wells in the Gulf.

`Massive Amounts'

One shale formation, the Haynesville Shale in Louisiana and Texas, may hold enough gas to meet U.S. demand for a decade, according to Chesapeake Chief Executive Officer Aubrey McClendon.

``What the hedge-fund community has been concerned about is you have massive amounts of natural gas,'' said Scott Gieselman, the managing partner at Natural Gas Partners, a private-equity firm in Houston. ``The amount of discoveries over the past five months has been prolific.''

Vince White, a vice president at Oklahoma City-based Devon Energy Corp., said investors have ``some unrealistic optimism'' about Haynesville. It will take at least 10 years to develop the formation, pipelines and related infrastructure, he said.

Devon became the largest producer in the Barnett Shale, the second-biggest source of U.S. gas, after its 2002 acquisition of Mitchell Energy & Development Corp., which pioneered techniques to tap resources beneath hundreds of feet of rock.

Ospraie Fund Folds

Ospraie had profited on XTO for years, Dwight Anderson, the New York investment firm's founder, said last week. The failed Ospraie Fund, which started in 1999, had returned an average 15 percent annually through 2007. XTO was its biggest holding.

XTO, founded in 1986, made dozens of acquisitions since 2002, increasing sales more than sixfold, data compiled by Bloomberg show. Chesapeake, founded three years later by McClendon, a co-owner of Oklahoma City's National Basketball Association team, made even more deals in the same period, growing 10-fold.

Investors aren't willing to bet against them. So-called short interest in XTO, EOG, Chesapeake, Houston-based Southwestern Energy Co. and Petrohawk reached the lowest levels since at least 2006 in July, according to data compiled by Bloomberg.

When XTO and Chesapeake took a similar beating seven years ago, both stocks gained more than 28 percent the next month. The last time both had bigger one-month declines in December 1998 the companies' market values surged five- and 10-fold, respectively, in the next two years.

Adding Gas Stocks

Willingham, the Houston hedge-fund manager, said he sold most of his gas stocks in June, before prices plunged, because valuations had gotten too high. Now he's buying XTO and others again.

Jason Putnam, an analyst who helps oversee $60 billion at Victory Capital Management in Cleveland, is targeting Chesapeake and Devon and said his firm may add shares of Houston oil and gas producer Apache Corp.

Investors who are willing to stomach possible declines of another 8 percent in the next few weeks can profit with Chesapeake and EOG, said Tom Orr, director of research at Weeden & Co. in Greenwich, Connecticut.

``Given the incredible level of pessimism and selling, that could just stop and turn on a dime,'' he said. ``It'd be foolhardy to be short here. It's down too much.''

To contact the reporter on this story: Dan Lonkevich in New York at dlonkevich@bloomberg.net.