Monday, August 31, 2009
Natural Gas Hedging
"For oil and natural-gas companies, the budding crackdown on US energy markets comes at an awkward time. ... Recent earnings reports from a number of US companies--including El Paso Corp., XTO Energy Inc. and Chesapeake Energy Corp. [CHK]--all showed a big boost from deals that locked in high prices for natural gas before that market sank to seven-year lows. ... [CHK] is among those warning that a poorly though out rush to lock the doors to energy speculation could diminish the depth of the market, hinder the company's ability to secure the best price and deprive it of the 'cash-flow certainty' that allows it to fund the ambitious drilling programs that bring on new supply. '[CHK] has serious concerns regarding how position limits on energy futures and a more restrictive application of hedge exemptions would impact how we deploy our risk-management strategy,' corporate finance manager Eliot Chambers [EC] argued in written testimony before the Commodity Futures Trading Commission on Aug. 5. Had the company not been able to lock in gas sales to offset the risk of falling prices, a $3.75 billion investment leading to the 2008 discovery of prolific new gas supply in Louisiana 'would not have been possible,' Mr. Chambers contended", my emphasis, Ann Davis at the WSJ, 12 August 2009, link: http://online.wsj.com/article/SB125003373396024123.html.
Here's how CHK can save money: fire EC and close his group. Marcus Rowland (MR), you don't need EC. Investment and financing decisions are separable. That CHK sold gas forward did not enable CHK to make any investments. If the investment had a projected NPV in excess of CHK's cost of capital, it should have been made. Consider a counterfactual. CHK sells for $22.41 currently. With 642 million shares, that's a $14.4 billion market cap. On 3 July 2008, CHK sold for $66.78. CHK could have sold 56.2 million shares to "fund" the drilling program. Better, had CHK sold 150 million shares for $10.0 billion and put the $6.25 billion remaining in the bank. With that money look at the investments CHK could make now at lower prices than 14 months ago. During 2008, CHK sold 51.75 million shares for $2.732 billion, or $52.79 a share. Nice going. We won't know if CHK "profited" from its "hedging" program for years, when we know what spot natural gas prices were during the period of CHK's "hedges". My conclusion: investment bankers sold CHK's financial management some useless financially engineered products.