Forecasters are predicting above-normal temperatures for the next two weeks in the eastern U.S. With natural gas production at record levels, there are worries that our supply levels will begin to rise. When you add it all together, the price of natural gas is likely to test its lows of $3/mmBtu. This is a worrisome scenario for several natural gas producers.
No company is likely more worried about a warm winter than Chesapeake Energy (NYSE:CHK). As the nation's second largest natural gas producer, it has a lot riding on the price of gas. It's one reason why the company has been investing heavily to grow its liquids production.
The company was caught flat-footed a few years ago after taking on too much debt in an all-in bet on the future of natural gas. That failed bet forced the company to shed billions of dollars worth of assets in an effort to shore up it's over-leveraged balance sheet. While it's come a long way in a few short years, it's still very leveraged to the price of gas.
According to the company, if natural gas prices stay around $3 for 2013, it's likely to earn around $0.28 a share for the full year. If the price were to revert back to the near $4 range seen in last November, then Chesapeake's projected earnings would likely jump to around a $1.05 a share. What should concern investors is that, while the company had hedged 76% of its fourth quarter 2012 production at a floor of $3.06, it had none of its 2013 production hedged as of its last investor report.
Chesapeake's not the only driller that's hoping for winter temperature prices to take a dive. Top 20 natural gas producers like Southwestern Energy (NYSE:SWN), Ultra Petroleum (NASDAQOTH:UPLMQ), and Cabot Oil and Gas (NYSE:COG) all could feel a pinch if prices fall further. All three have much higher exposure to natural gas, as they've been slower to join the liquids drilling boom.
Warm winter weather will not affect all companies in the same way. As mentioned, Chesapeake's lack of production hedges could really impact its bottom line. Also on that list is Ultra Petroleum which, as of its last report, had yet to hedge its 2013 production. Even global oil giant and top U.S. natural gas producer Exxon (NYSE:XOM) had yet to lock in its 2013 hedges. While the company has worldwide operations, it still gets more than 15% of its total energy production from U.S. natural gas.
Southwestern, on the other hand, had about 30% of its 2013 production hedged, while Cabot also remains fairly well hedged. By hedging production, both companies have limited some of the risks of a warmer-than-expected winter. While both would rather see rising gas prices, neither company has as big of a reason to worry.
Hedging, of course, can cut both ways; it can take away the upside in profits when prices rise. That missed upside isn't as big a risk as the downside from low prices. Despite a much-improved balance sheet, Chesapeake appears to stand to lose the most from warmer weather.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends Ultra Petroleum. The Motley Fool owns shares of ExxonMobil and Ultra Petroleum and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, Short Jan 2014 $15 Puts on Chesapeake Energy, Long Jan 2014 $30 Calls on Ultra Petroleum, Long Jan 2014 $40 Calls on Ultra Petroleum, Long Jan 2014 $50 Calls on Ultra Petroleum, and Short Jan 2014 $20 Puts on Ultra Petroleum. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.