Tuesday, April 10, 2012

Natural Gas: Chesapeake Goes Naked (CHK; RRC)

A couple months ago I mentioned the "awful choice" that gas E&P companies would be facing for wells they had just started drilling:
Do they shut in new wells upon completion, after literally throwing money down a hole or do they start producing, knowing that, as storage topped off, they would be forced to sell on the cash market?

Here CHK is facing a different "awful choice". Do they hedge against further price declines by selling forward their production, locking in today's price, or do they dramatically scale back production in the hope that at least some of their competitors (many of whom have wells producing natgas fluids which will help keep them afloat) will also cut back?

Tough call, especially for a cash-strapped balance sheet.
From CNBC:
 Chesapeake Energy, the second-largest natural-gas driller in the U.S. and an active user of derivatives for hedging against the ebbs and flows of its core business, removed most of its 2012 derivatives positions, leaving the company naked to big dips in natural-gas futures prices just as they were headed for a ten-year low.

Late last year, the company removed most of its gas and oil hedges for 2012 and 2013, according to documents and people familiar with the matter, believing that prices were at or near a bottom.
At that time, natural-gas futures were trading just under $4. Monday morning, however, prices plummeted to roughly $2.06 per million British thermal units, their lowest level since February 2002. So far this year, Chesapeake [CHK  21.88    0.41  (+1.91%)   ] shares are off roughly 3 percent, currently trading at about $22.
Chesapeake “is unhedged for natural gas in 2012 because we believe little further downside exists,” wrote the company in an April investor presentation. In a statement, a company spokesman added that “we are confident the market will use price to balance supply and demand for natural gas in the U.S.”
Still, going so-called naked to the strip, or having few or no hedges against where a market is currently trading, is a sharp turnaround for a company that brags in investor materials of being “the best in the industry” at natural-gas hedging. 

Since 2006, Chesapeake has made an estimated $8.4 billion through derivatives trading, according to company literature. In this case, the company lifted off a batch of swap positions it had, pocketing the difference between the gas levels the swap had been pegged to and the price they were trading at last fall.
Exiting the trades was profitable, says someone familiar with the matter, even though doing so left Chesapeake without any downside protection against prices this winter....MORE