Looking at Natural Gas? Buy Advantage Oil & Gas Ltd. and Tourmaline Oil Corp.

Advantage Oil & Gas Ltd. (TSX:AAV)(NYSE:AAV) and Tourmaline Oil Corp. (TSX:TOU) are major exceptions to the struggling natural gas market.

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Natural gas prices haven’t been immune to the recent global rout in commodity prices. Down 35% in the past year and a rapid 10% in the last 30 days alone, most natural gas producers have seen profits turn to losses fairly quickly. There are, however, two companies that stand out in an industry rife with negative earnings.

Advantage Oil & Gas Ltd. (TSX:AAV)(NYSE:AAV) and Tourmaline Oil Corp. (TSX:TOU) are major exceptions to the market right now. Long ago, both positioned their businesses to survive depressed natural gas prices that have existed for much of this decade.

How are both planning to not only survive, but thrive once the market rebounds?

Low costs are the key

Natural gas prices have averaged $3.30 over the past 10 years, spending extended periods below $2.50. This has forced many companies with production costs above $3 out of business. Advantage and Tourmaline, meanwhile, are so lean that both can generate profits even if natural gas prices plunge below $2.

Estimates show that Advantage’s total cost of production is $1.04 per mcf, the lowest in Canada. Tourmaline, meanwhile, can remain profitable at $1.49 per mcf, the second lowest.

“We should be prepared to survive and grow in this $3 environment, even down to $2.50 price. That’s going to be the reality for the next three years. I don’t think we are going to see a significant lift,” said Andy Mah, CEO of Advantage Oil & Gas Ltd.

“You got to chip away at all of those and try to be profitable and one of the key for us is to finance, build and control our own infrastructure—that’s what gives you the low op cost, and you can survive these low prices,” said Michael Rose, CEO of Tourmaline Oil Corp.

Low costs mean major profits when prices rise

Being the number one and two lowest-cost producers means Advantage and Tourmaline should survive nearly any pricing environment. When prices rebound, this also means they should enjoy the highest profit margins.

“If gas got to $4, we will have tremendous earnings—it’s been painful with various oversupply scenarios. In the long term, we truly believe gas is going to get there,” Michael Rose commented.

Fortunately, both companies are sticking to their low-cost projects, resisting the urge to snap up discounted assets of higher-priced competitors. Tourmaline remains focused on its Alberta Deep Basin and B.C. Montney properties, while Advantage is exclusively focused on its gas properties in Montney. Both should have no issue making it to the next natural gas bull market.

Valuations look reasonable

Tourmaline generated $1.72 in profits per share last year, allowing it to trade at 18.3 times earnings. Advantage posted $0.40 in earnings per share, meaning shares trade at 18.5 times earnings. Trading at market multiples at industry trough levels means that shares in both companies have plenty of upside as natural gas markets stabilize and correct in the coming years.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Ryan Vanzo has no position in any stocks mentioned.

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