A Look At Chesapeake And Range Earnings: Why Are They Hedging Now?

| About: Chesapeake Energy (CHK)

Chesapeake Energy (NYSE:CHK) and Range Resources (NYSE:RRC) just reported their latest earnings. Both Chesapeake and Range shares sold off after their reports. With the rebound in natural gas prices, how these companies have fared with their reported results is especially important for investors. It's also important to see how each is positioned if natural gas prices continue to rise.

Chesapeake Energy

No company has been more impacted by low natural gas prices than Chesapeake. Former CEO Audrey McClendon was a natural gas bull and didn't hedge Chesapeake's production as prices dropped. The company has been forced to retrench and sell assets. According to Chesapeake's earnings report:

  • Adjusted net income per fully diluted share of $0.30 increases 67% year over year

  • Adjusted EBITDA of $1.134 billion increases 35% year over year

  • Total production increases 9% year over year to 4.0 bcfe per day

  • Total production increases 9% year over year to 4.0 bcfe per day. The company's production consisted of approximately 3.0 billion cubic feet (BCF) per day of natural gas and approximately 157,000 barrels (bbls) per day of liquids, comprised of approximately 103,000 bbls of oil and approximately 54,000 bbls of NGL.

  • Marcellus Shale (Pennsylvania, West Virginia): Chesapeake is the largest leasehold owner in the Marcellus Shale, which spans from northern West Virginia across much of Pennsylvania into southern New York. The company recently achieved a gross operated natural gas production milestone of more than 2.0 bcf per day. As natural gas prices have recovered from last year's historically low levels, the company has benefited from the strong growth and returns in both the northern dry gas and the southern wet gas portions of the play.

The biggest problem with Chesapeake has been the company's high debt load and having to unload assets to raise cash. The market's interpretation is that many of the disposals have been at fire-sale prices. Just last week, Chesapeake sold 162,000 net acres of natural gas properties in the Marcellus Shale to Southwestern Energy (NYSE:SWN) for only $93 million. Investors in Chesapeake are quite frankly growing tired of all the asset sales, especially at cheap prices. The focus at Chesapeake should be on drilling, but they need to raise cash to fund debt payments and drilling operations. So in fairness to current management, they didn't put the company in this position and are dealing as best as they can with the hand they were dealt.

What frustrates me about Chesapeake is now they decide to hedge production. Where were these hedges last year? According to Domenic Dell'Osso Jr. Executive Vice President and Chief Financial Officer:

Next, I would like to address our hedge position for 2013 and 2014. In 2013, we have put in place downside protection of approximately 78% of our projected natural gas production at an average price of $3.72 per Mcf. On the oil side, we have downtime protection on roughly 88% of our expected volumes at an average price of $95.43 per barrel. For 2014, we used recent strength in natural gas prices to hedge approximately 13% of our projected cash production at $4.33 per mcf. We have also put in place 2014 oil hedges that project our downside on approximately 40% of our projected production at an average price of $93.63 per barrel which is well above the current NYMEX strip.

Again, I can understand the company looking to get more conservative, but this is not what I'm looking for. I just hope current management doesn't get too conservative and we're all asking for Aubrey McClendon back.

Range Resources

Range Resources has sold off over $6 since earnings were announced last week. The reason for this is that earnings came in at 11 cents a share versus consensus of 18 cents a share. First quarter revenue missed as well, falling short of the $390 million expectation. First quarter revenue was $319.2 million, which grew 27% from the first quarter of last year. According to the company, highlights were:

  • Record daily production of 876 Mmcfe per day, an increase of 34% over prior-year quarter

  • Cash flow was $219 million, an increase of 34% as compared to the prior-year quarter, despite lower prices

  • Unit costs decline 10% as compared to the prior-year quarter

  • Liquids-rich Marcellus in southwest Pennsylvania continues to provide impressive results

  • Refinanced higher cost debt with completion of a $750 million senior subordinated notes offering at 5%

  • Asset sale for $275 million closed Apri1 1

The company was hit with several non-recurring charges:

Several non-cash or non-recurring items impacted first quarter results. A $96.8 million mark-to-market commodity hedge loss was recorded. A $35.0 million provision for a lawsuit was recorded. A $42.4 million expense for mark-to-market for the increase in the Company's common stock held in the Company deferred compensation plan (which was fully funded on the date of grant), and $12.3 million of non-cash stock compensation expenses were recorded. With the full derivative portfolio now subject to mark-to-market accounting, the Company recognized an $81.4 million reduction in value of its hedge portfolio during the month of March with the improvement of natural gas prices during the month.

You would think a natural gas company would welcome higher prices, but Range actually lost money as prices rose. As Roger Manny, Chief Financial Officer and Executive Vice President, said on the earnings call:

Natural gas futures prices increased between the end of the year and the end of the first quarter. And while this is good news, the gas price increase made our hedges less valuable at the end of this reporting period compared to the end of the last reporting period. And this explains the $97 million noncash mark-to-market loss on our hedges, which was primarily responsible for our GAAP net loss.


As I have said in my previous articles, How To Play Rising Natural Gas Prices and 5 Natural Gas Stocks To Own, I am bullish over the long-term on natural gas (NYSEARCA:UNG). But what's the point of owning these stocks if natural gas prices rise and they don't benefit? I understand the low prices of last year scared many operators, but now is not the time to get conservative. They survived the downturn and should be looking to the future and not focusing on the past. Management of these 2 companies are grateful that prices have rebounded and are happy to get a little more than last year. That's not a strategy I would advocate and has me re-evaluating these 2 companies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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