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Think Natural Gas Is Heading Higher?

The current Baker Hughes natural gas rig count, which is used as a measure of activity in the oil and gas industry, is quite interesting. The North American natural gas rig count was a mere 122 on April 8, which is a small fraction of rig counts in prior years. For example, in April of last year, the rig count was over 300.

In fact, in my data set from Baker Hughes, which goes as far back as the 1990s, this is the low. And in some years, like 2006, the number was over 1,500. So clearly, we are seeing a real and dramatic supply-side response. And this is leading me to become more bullish on the commodity.

Here are the two stocks that I would get into to take advantage of future strength in natural gas prices.

Encana Corporation (TSX:ECA)(NYSE:ECA)

Despite Encana’s struggles of late and badly timed effort to increase its exposure to “oily” production, the fact remains that the company still provides the most leverage to natural gas in terms of volume; it had natural gas production of 1,635 Mmcf/d in 2015, representing 67% of production.

With its fourth-quarter results, the company has embarked on a plan to reduce capital spending, continue to improve its cost performance, and improve its balance sheet. Its capital spending plans for 2016 were reduced by over 40%. Encana had over $270 million of cash on its balance sheet as of the end of the fourth quarter. The company has continued to use this cash to retire some of its outstanding senior notes, which will effectively reduce interest costs going forward.

Encana’s stock has a two-year return of -67.18% and a year-to-date return of 13.46%.

Peyto Exploration and Development Corp. (TSX:PEY)

Peyto remains the lowest-cost producer of the intermediate natural gas exploration companies, which makes it an ideal choice for tough times. Natural gas makes up over 90% of the company’s production, which is growing–this is not typical in this part of the cycle. Furthermore, the company’s balance sheet remains strong; its $1 billion credit facility is only 63% drawn as at December 31, 2015, and the company still pays a dividend, which stands at a healthy 4.32%.

Peyto’s stock has a two-year return of -24.7% and a year-to-date return of 12.3%.

Bottom line

In summary, it appears that the supply-side response from energy companies is in full swing, and with drilling levels at lows not seen since at least 2000, the sector seems to be setting up for a supply/demand balance that will prove to be very attractive for energy companies in the medium term as this dynamic makes its way through the system.

Two energy plays for your watch list

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Fool contributor Karen Thomas owns shares of EnCana Corporation.

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