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TORONTO (GlobeinvestorGOLD)—A lot of attention has been focused over the past six months on how much crude oil prices have risen, but the price of natural gas has climbed even farther and faster than crude—rising more than 100 per cent over the past year. That is putting pressure on companies, such as plastic producer Nova Chemicals Corp., which rely on natural gas as a feedstock for their business.
For Nova, the rise in natural gas prices has an air of déjà vu about it. The company has only just started recovering from the financial impact of two years worth of high resource prices and slumping demand for the petrochemical products it produces. Nova is a major producer of polystyrene, polyethylene and other plastic products derived from natural gas.
Although Nova is now headquartered in Pittsburgh, Pennsylvania, it was originally based in Alberta, where it was set up as an arm of the provincial government—an attempt to use the province's resource industry as a foundation for other industries. One of the main benefits of locating Nova's petrochemical plants at Joffre in southern Alberta was that natural gas prices were lower in Canada, giving Nova a substantial competitive edge over U.S. companies.
The differential between Canadian gas and U.S. gas prices is a lot smaller now thanks to the Alliance pipeline, which has connected Alberta to the central gas market in Chicago. And Nova has been subject to the same skyrocketing rise in gas prices its U.S. competitors have. The company managed to produce a better than expected result in its most recent quarter, but some analysts wonder how long it will be able to do so if prices stay as high as they are.
In the latest quarter, Nova made a profit of $4-million (U.S.) or 5 cents a share, up from a loss (before unusual items) of $30-million or 35 cents in the same quarter of 2002. The company's profit was well ahead of the Wall Street consensus estimate, which was looking for a loss of 39 cents a share—but most of the improvement came as a result of price hikes that Nova instituted, as well as the revoking of favourable contract terms for certain customers.
The question some analysts are asking is whether the company will be able to maintain its prices if the price of gas remains high for a sustained period, as many industry watchers believe it is likely to. Natural gas experts say the price squeeze is a simple matter of supply and demand, with demand for the commodity rising steadily while production has failed to keep pace. "It's a scramble for Nova and other companies to raise prices high enough to recoup their higher costs," David Silver of J.P. Morgan told Reuters.
Nova still has an edge on most of its competitors, since they are forced to use higher-cost natural gas from the Gulf of Mexico while Nova has access to lower-priced local gas. Some analysts believe that other producers will feel the pain long before Nova does. Raymond James analyst Bob Hastings, for example, has a "strong buy" on the stock, saying as far as costs are concerned, "there's nobody really cheaper than Nova in North America."
Still, if natural gas costs remain high then Nova will continue to feel the pressure on its bottom line, since feedstock costs make up about 75 per cent of the chemical company's expenses, and two-thirds of its feedstock is natural gas, the rest is oil. In a recent research report, BMO Nesbitt Burns said that while Nova's stock price has fallen far enough to make it appear attractive, "The timeliness of the earnings recovery remains in question."
In a report issued after Nova Chemicals sold its 37-per-cent stake in methanol producer Methanex last month, Sanford Bernstein said the sale made it even more negative towards Nova, since Methanex contributed a sizeable portion of Nova's earnings.
The brokerage said owning a stake in Methanex was also a hedge against higher gas prices because the methanol producer benefited from them—since most of its operations in New Zealand and elsewhere use low-priced gas, but it fetches high prices for its methanol in North America.
Mathew Ingram joined The Globe and Mail's online news team in June of 2000, after spending four years as the Western business columnist, based in Calgary.