What's Holding Chesapeake Back This Quarter?

Chesapeake Energy could see only a modest gain in revenue in the second quarter despite a potential rise in production. This could occur due to unrealized gains from derivatives.

Jun 19, 2014 at 9:40AM

The second quarter isn't over, but in preparation for the release of Chesapeake Energy's (NYSE:CHK) earnings report, the company could record little to no growth in sales compared to last year. This potential stagnation in revenue is despite the expected rise in production and elevated natural gas and oil prices. How is this possible? Four words -- unrealized gains from derivatives.

Rise in production
The company expects to show an increase in its production, mainly in oil and natural gas liquids. Its Eagle Ford shale operations are likely to rise by the number of producing wells, which will translate to higher output. The Eagle Ford shale's oil output accounts for 64% of its total mix. Moreover, the company plans to further expand its NGL production in the coming months, as indicated in the table below.

Chk Q

Source of data: Chesapeake Energy

During the first quarter, severe winter weather affected Chesapeake Energy's production in certain locations, mainly in the Mid-Continent region and in the Eagle Ford shale. These circumstances have subsided in the past couple of months. As a result, production in these regions is likely to pick up in the second quarter.

Despite an expected rise in production in oil and NGL, the company's natural gas production is projected to inch down during the quarter. In total, Chesapeake Energy's production is likely to rise during the second quarter.

Higher market prices -- lower realized prices
The current market prices are higher than the prices recorded in the second quarter of 2013, as indicated in the table below.  

Chk Q Price

Source of data: Chesapeake Energy's website .

Despite the high price of natural gas, the company's sales in natural gas are projected to remain flat this quarter. Total revenue from production is also expected to rise slightly, by  1.3%.

Chk Q

Source of data: Chesapeake Energy's website .

But if prices and production are expected to pick up, why would the company's sales from production only inch up during the quarter?

In the second quarter of 2013, the company recorded $590 million in unrealized gains from its natural gas and oil derivatives. These derivatives are in place to hedge in case of a sudden drop in energy prices. But as I pointed out in a recent article, the company's hedging system is likely to result in lower realized prices versus the same quarter last year. Moreover, in the first quarter of 2014, the realized price of natural gas was $3.27 even though the market price was $4.70.

This quarter, the company's realized price for natural gas could remain close to $3.90 even though the market price was $4.60. In other words, even if the price of natural gas remains elevated, the company's realized price could be much lower than the market price and close to last year's realized price.

Therefore, the company's hedging system could partly offset the rise in production and elevated oil and natural gas prices. 

In conclusion...
Chesapeake Energy is likely to further increase it output, mainly in oil and NGL, but the company's hedging system could partly offset this growth and keep revenue close to the same quarter last year.

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Lior Cohen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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