Chesapeake: When Gas Prices Will Recover

by: Judy Weil

Chesapeake Energy Corp. (NYSE:CHK), the (former?) darling of the natural gas industry, has had a rough quarter. CEO Aubrey McClendon had to sell his 33 million shares in the company to meet margin calls. Resultant share dumping and declining natural gas prices have sent stocks from around $50 at the end of September to $14.50 at Tuesday’s close.

Executives are emphatic that there is no reason for worry. Cash is at $1 billion and expected to double by year’s end. The company sold assets and continues to market others to raise cash, executives say. Although reporting a share offering to raise liquidity on Thanksgiving eve was ill-timed and disastrous for shares.

Chesapeake has hedged gas prices and maintains that natural gas is America’s future. Peak oil has arrived, says McClendon, and natural gas is mostly produced in North America. So far, Chesapeake has not really made cuts and investors seem worried over whether that business model can be sustained for long in this environment.

What analysts and investors seem to be looking for on Chesapeake’s earnings call is some kind of certainty: That the company will survive, that gas prices will rise, that the market will rebound. Nobody has a crystal ball, but McClendon’s response and technical analysis in the last paragraph below should be of interest to natural gas investors.

From Chesapeake’s Q308 Business Update Call:

Q: I think you guys are definitely at the forefront of doing some really good financial deals. But I think the problem certainly I have is when I look at your cap ex versus your operating cash flow, over the next couple years you have to perpetually sell this amount of assets in order to fund your program or your program has to get cut back. So that’s kind of where I’m at. I don’t understand how you’re going to do this year in and year out when we’re already looking at your asset sales that you’re doing already.

A: Embedded in your question is the presumption that assets can’t be sold. Tens of billions of dollars are sold every year in this industry. I’m surprised that you find it hard to believe that there is not a ready market for the type and quality of assets that we have. We’ll make more money selling leaseholds than we ever will drilling wells. Again as I told you before that by the time this year is over we will have monetized an amount of assets that will exceed $10 billion. If you include the carries with that and have made an 80% profit margin on that, going forward I think absolutely I want the challenge and I want the organization to have the challenge to be able to find $1 billion of assets a year, $1.5 billion of assets a year.

There’s some presumption in your question that we have no capability of throttling back our business. We’ve already cut back $4.7 billion of expected cap ex just in the last month. If gas prices go to $5, if they go $4, if they go to $3, we’ll cut back. We are completely capable of laying [inaudible] and we will do that. We are completely capable of driving down a lease price. We’re completely capable of saying no to a lease.

Every time we lose money on hedges you tend to make money for the next six to eight quarters and then you get a chance to do it all over again. Remember we lose money when there’s a gas price spike so that happened in the first and second quarter of this year. We lost money on hedges. We’re going to make money in the second half of ’08 and in ’09 and probably ’10.