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Chesapeake View On Natural Gas Prices - Investment Implications

Below are notes from a group investor meeting with two senior directors of investor relations and research from Chesapeake Energy (CHK). They are obviously very bullish on natural gas (UNG). High natural gas prices would be bullish for Chesapeake Energy's stock, as the company is one of the largest producers of natural gas in North America and has minimal natural gas price hedges in place. One other interesting play on natural gas that I have exposure to is Geomet Preferred (GMETP), which pays a high yield and is convertible into a highly levered natural gas equity.

Notes on Chesapeake's Natural Gas View:

Natural gas supply has plateaued, is rolling over. Demand should increase 10-15% over the next few years. Additionally, imports from Canada are declining and exports to Mexico are increasing.

Marcellus supply additions should be measured by takeaway capacity, not productive capacity.

Marcellus production increases are offset by Haynesville and Barnett declines. This is true across the industry, not necessarily specifically for Chesapeake.

Liquids rich production growth is offset by conventional natural gas production decline.

Unconventional gas plays are plateauing and entering decline phase. It will be hard to stem that decline without substantial new drilling activity. Marcellus is an exception, it is still very much in the strong growth phase across the industry and will be for a while

Need $4.75 for Haynesville to generate a 15% rate of return, $5-5.50 for Barnett. Those probably aren't very scientific return targets, rather, there is a spectrum off IRRs within a basin that is driven by location, pad drilling etc. Perhaps those are good averages for an entire basin but some wells you might drill at a lower price and some you may not drill even it $8.00.

Would likely need higher prices than that to see rigs return to those plays, as other alternatives earn higher rates of return than 15%. This implies a strip price higher than $4.25 - the current 5 year strip is too low.

The last thing they would consider is storage. Last year on April 1 we emerged with an 800 Bcf YOY surplus, this year looks like the range will be a 500 to 700 Bcf YOY deficit. This is obviously a shorter- term determinant of prices (at least until Nov.1), but suggests that the negative "fat tail" risk we saw in prices last year is much reduced in 2013.

Note: I vetted my notes with the investor relations senior directors prior to this publication to ensure that I accurately captured their thoughts. Also, both Chesapeake and Geomet Preferred are highly levered companies in a cyclical business, and as such they may be more volatile and incur more risk than other investments. Also, Geomet (OTCQB:GMET) is a small public company, which entails its own set of risks. Caveat emptor.

Source: Chesapeake View On Natural Gas Prices - Investment Implications

Additional disclosure: I am long GMETP