Will Chesapeake Energy Corporation Meet Its First Quarter Goals?

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During the first quarter of 2014, the oil and gas market heated up. Despite these developments, shares of Chesapeake Energy (NYSE: CHK  ) didn't perform well and have lost nearly 1.5% of their value so far 2014. But was the company's performance really that bad in the past quarter? In anticipation of the company's earnings report for the first quarter, which will be released on May 7, let's see what investors should expect. 

The U.S. oil market heated up in the first quarter of 2014, and the average quarterly price of WTI crude was roughly 4% higher than in the parallel quarter in 2013. Furthermore, based on the company's 2014 guidance, its oil production is expected to rise by 14% to reach 10.6 mmbbl. This means the company's oil revenue rose by 18% because of higher prices and production.

The price of natural gas also rallied during the 2014 winter and passed the $6 mark on more than one occasion. The average quarterly price of natural gas was around $4.7. But let's be conservative and assume the company's realized price was around $4 (mainly because of the derivatives contracts it holds -- more on this issue below). Since Chesapeake's annual production is expected to inch down by 1% to 1,100 Bcf, its quarterly production may have declined to 270 Bcf -- nearly 0.7% lower than the first quarter in 2013. Despite this modest drop in production, in the first quarter, natural gas sales were nearly 86% higher than last year. 

Even though the price of NGL took a nosedive in the past several weeks, it was still mostly hovering close to the $50 mark during January and February. Moreover, the company estimated its NGL production to rise by roughly 50% to 7.4 mmbbl during the first quarter. Therefore, even if we were to assume the average price was $40, this brings Chesapeake's sales from NGL to nearly $300 million, which is 115% higher than the same quarter in 2013. 

Finally, the company estimated its net margin from marketing, gathering, and compression operations to drop to $62.5 -- nearly 37% lower than last year. In 2013, this business segment's operating profit was only 1%. Moreover, this segment's profitability is likely to be even narrower this year, which is likely to have very little impact on Chesapeake's earnings. 

Keep in mind, the numbers listed above should be taken with a grain of salt for two main reasons: Winter conditions and derivatives contracts. 

Extreme winter conditions have most likely cut down production in parts of the U.S. such as the Eagle Ford shale in South Texas and the Northern Marcellus shale in Pennsylvania: The weather already took its toll on the Eagle Ford during the fourth quarter of 2013, as production dropped by 8% from the third quarter. The poor weather conditions throughout the U.S. could have reduced production of oil and natural gas so that the company might not meet its 2014 guidance. 

The other factor to consider is the derivatives contracts the company had purchased in order to limit its exposure to fluctuations in the energy market. Last year, Chesapeake acquired options and future contracts to protect against a sharp fall of natural gas and oil prices. Since these options are very expensive, the company reduced this insurance cost by setting a ceiling for the prices of oil and natural gas. But only a portion of the company's oil and gas output is hedged with options. Because of this ceiling, which is set at $4.39 for natural gas in the first quarter of 2014, Chesapeake didn't fully benefit from the rise in natural gas prices. Therefore, for the first quarter of 2014, the average realized price of natural gas was lower than the quarterly average price of natural gas of $4.7.  

The bottom line
I think Chesapeake might not meet its production guidance on account of the harsh weather conditions. Nonetheless, the high prices of oil and natural gas are likely to more than offset any drop in production. Therefore, the company is likely to show a rise in revenue and improve its profit margins in the first quarter. 

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Lior Cohen

Lior has been a contributor for the Fool since 2012. His main interests are in commodities, and energy and materials companies.You can follow him on Twitter to stay up to date with his industry analysis. @tradingnrg

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8/27/2015 4:00 PM
CHK $7.02 Up +0.68 +10.73%
Chesapeake Energy CAPS Rating: ****