Chesapeake Energy Corp.
Consequences of Low Prices Yet to be Felt?

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By rjf53
July 16, 2009

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Where the price point settles out is anyone's guess.

The low price point (below the cost to produce) at present will correct itself and I think we will see $10 NG again.

While I feel compelled to remind everyone that in the grand scheme of things I don't know squat about the NG industry, I can't help wondering how much potential danger to investors lurks in this sentiment.

While a lot of attention is given to the day to day gyrations in the price of NG and where it might be headed, I'm wondering more and more if the critical question isn't; "for how long?" It seems to me due to past hedges being in place that many of the consequences of these low prices have probably yet to be felt industry wide. I doubt I could string together a post that would be concise or coherent enough to express my concerns so instead I'll try asking a question and/or making some statements.

I hear a lot about "cost of production" so allow me to use your linked papers example (finding cost $1.60 and operating cost of $2.00) as a basis for my question. The implication I hear time and again is that when prices are below the cost of production ($3.60) this will force a producer to curtail production, but if a company is depended on a set amount of cash flow to fund it's business or pay it's debt isn't the real number $2.00? To me this is a bit like an individual whose primary wealth resides in their 401K and he/she loses their job. It matters little what they paid for their investments or what they believe they will be worth at some point in the future if they need cash to survive now they will have no choice but to sell their assets at whatever the market is offering.

In regards to CHK when I compare their situation to roughly 6 months ago I see where they have succeeded in reducing their debt and pushing back the early dates when it will come due but this is offset by the continued deterioration in the spot price along with the fact that they have gone from a well hedged company to a nearly un-hedged position. So if the current situation persists (or gets worse) even a few months longer than the company (Aubry) anticipated at what point does a decision such as the one to shut in production, which the whole industry needs, get taken out of their hands due to their need for cash flow?

This is a bit of a déjà vu moment for me in that it reminds me of when I saw article after article where I was told about cut backs in drilling and I kept seeing that no one was actually curtailing their production. Now it seems that I am supposed to accept that low prices will force curtailment of production and I'm wondering, for some at least, if low prices will force them to keep production up because of the need for cash flow.

When the rig count was dropping and production wasn't, I was worried that people "weren't seeing the forest for the trees" now I wondering if people shouldn't be paying more attention to the "trees" before they start making grand assumptions about the forest.

B (Who thinks time is ultimately every bit important as price)