Natural Gas Keeps Falling, but Chesapeake Energy Is Ready This Time Around

Chesapeake Energy's hedging strategy looks like it will be a benefit for shareholders as natural gas prices continue to approach $4.

Jul 16, 2014 at 9:45AM

From Oct. 1, 2011, to March 14, 2013, natural gas spot prices -- the most common one used is the "Henry Hub" spot price -- stayed below $3.77. For the first six months of 2012, the spot price was below $2.75 per MCF:

Henry Hub Natural Gas Spot Price Chart

Henry Hub Natural Gas Spot Price data by YCharts

Why is this short history lesson important? In short, to illustrate just how far the industry, and natural gas producer Chesapeake Energy (NYSE:CHK) has come. From mid-July 2011 to mid-May 2012, Chesapeake would lose 59% of its value, and the early seeds of the eventual ouster of co-founder and CEO Aubrey McClendon would be planted: 

CHK Chart

CHK data by YCharts

G

Chesapeake CEO Doug Lawler. Source: Chesapeake Energy

Today's Chesapeake Energy, led by CEO Doug Lawler, brought in after McClendon's ugly ouster as CEO has continued the deleveraging that was begun before his tenure, while also implementing a more cost-conscious and disciplined approach to running the company. Where McClendon was hell-bent on making the biggest company he could, Lawler and his team have sold off assets, reducing the company's capital requirements, and focused exclusively on profitable growth.

With that perspective, let's take a look at where things stand with Chesapeake Energy today, especially as production increases combine with the summertime lull in demand to push prices almost down to the $4 mark for the first time since January, when they fell to $3.95. 

Industry focusing on oil and liquids
It's important to remember that this was just a few years removed from very real fears that the domestic supply of natural gas was almost exhausted. The shale reserves were known, but until hydraulic fracturing and horizontal drilling technologies revolutionized the industry, those reserves were inaccessible. After nearly two years of exhaustingly competitive expansion and growth, the industry as a whole realized it was killing itself, and overproduction had pushed the price down to the point where everyone was losing money. Today, that's changed:

 

To paraphrase Pickens, the problem today is almost reversed as much of the industry focus is on production of oil -- not natural gas -- largely due to the price premium per unit of energy that oil gets today. Even Chesapeake Energy has been drawn by the call of good money in oil, adding significantly to both its reserves, and its oil production in recent years. While natural gas still makes up the lion's share of Chesapeake's production, as of May 2014, Chesapeake management was projecting that production of oil and natural gas liquids (think propane, butane, etc.) would grow as much as 33%, while natural gas production would only grow 4-6%. 

How important are liquids to Chesapeake? Think about it this way:

G
Source: author

In the first quarter of 2014, the company's total production of liquids and natural gas was equivalent to 60.8 million barrels of oil. Of that total, 43.3 mmboe -- or 71% of production -- was natural gas. But natural gas only accounted for $697 million -- less than 39% -- of the total of $1.77 billion in natural gas, oil, and NGL sales. Going back to the same periods in 2011 and 2012, NGLs weren't even listed on the company's 10Q, and natural gas was the dominant source of both production and sales. 

Disciplined hedging approach 
I recently wrote this article that discusses the importance of hedging for Chesapeake, and if the recent trend of gas prices falling continues, this strategy could turn into a real boon for the company over the summer. This image, from a recent Chesapeake Energy presentation, further highlights just how much of the company's production has a floor price:

G

While hedging can limit the upside, it's a great way to protect the downside, and also guarantee acceptable rates of return. With natural gas' seasonality, a well-executed hedging strategy can lead to getting better than market prices at times. 

Looking down the road 
At some point, natural gas prices are going to start rising again. As Pickens described, the majority of drilling rigs are committed to oil, and until the market turns in favor of natural gas, producers will keep focusing where there's money to be made. Natural gas has some tailwinds in its favor, though.

  • The current political climate makes it a favorable source of electricity production versus coal. 
  • Momentum is growing to increase its use as a heavy transportation fuel versus diesel. 
  • Significant exports are coming online within the next 18 months. 

Combined, these three things will lead to increased demand, which should mean higher prices in the long term. Chesapeake management has shown the discipline to negotiate the changing environment, and I expect that to be the case as demand for -- and the price of -- natural gas increases. Combined with the diversity of oil and NGLs in its portfolio, and Chesapeake is in pretty good shape today. 

This energy tax "loophole" could make you rich
And it's legal. And it's not going away anytime soon. The IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Jason Hall 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers