Santa Brought Natural Gas Profitability For These E&P Developers

 |  About: Chesapeake Energy Corporation (CHK), Includes: ROSE, UPL
by: David White

Since December 5, 2013 U.S. Nymex natural gas prices have floated constructively above $4/mmbtu. In fact they have close consistently above $4.20/mmbtu since December 9, 2013. Nymex natural gas futures prices closed at $4.46/mmbtu on December 19, 2013. This is a big deal because prices hit a low of $3.129 for 2H 2013 on August 8, 2013; and they hit a Q4 low of $3.379/mmbtu on November 5, 2013. The higher prices are great news for natural gas E & P companies. It is especially good news for low cost, large producers of natural gas, who stand to reap the greatest benefits from these new higher prices.

The chart below shows some of the lowest cost natural gas producers in the U.S.

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The figures above include the development costs. These actually fall into the DD&A (Depreciation, Depletion, and Amortization) category shown for Ultra Petroleum Corp. (NYSE:UPL) -- the lowest cost natural gas producer -- in the break out box of its costs. The other two companies (in this chart) that are currently fully profitable with no hedges are Chesapeake Energy Corp. (NYSE:CHK), and Rosetta Resources Inc. (NASDAQ:ROSE).

Chesapeake Energy is easily the biggest of these companies. It has a natural gas production forecast for FY2013 of 1,080 - 1,090 Bcf. For the sake of this assessment we will say that 1 Mcf equals 1 mmbtu of natural gas. Hence 1,085 Bcf equals 1,085 * 1,000,000 * price/Mcf. For the sake of this assessment, I will say CHK's natural gas production will be about the same in FY2014 as the forecast for FY2013. The tables below describe CHK's natural gas hedging positions.

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CHK will have to sell 233 Bcf at $4.23/mmbtu (swaps). CHK has 3-way collars for 18 Bcf. These last mean CHK will get a maximum of $4.70/mmbtu for those 18 Bcf. It will get the market price of the natural gas when that price is between $4.00/mmbtu and $4.70/mmbtu. CHK will get $4.00/mmbtu when the market price of natural gas is between $4.00/mmbtu and $3.50/mmbtu. Below that it will get $4.00/mmbtu - ($3.50/mmbtu - market price/mmbtu). CHK also has 12 Bcf of swaptions at $4.80/mmbtu. In other words it can effectively convert these swaptions into $4.80/mmbtu swaps at its option. As you can see from the above, this will leave the bulk of CHK's natural gas production or about 822 Bcf unhedged. This means CHK will get a lot more money for its natural gas if the price averages closer to $4.30/mmbtu than if it averages closer to $3.70/mmbtu. For the above example (leaving out the collars and the swaptions which only cover 30 Bcf total), CHK would have higher revenues of about $493 million (without any extra work). This is a great Christmas present for the company and for investors. When the all-in costs for CHK are below the sales value, the extra money from the higher priced sales is all pure profit (allowing for taxes, etc.). CHK's Q3 2013 EBITDA was $1,158 million. The extra $493 million would amount to approximately one half of the quarter's EBITDA. That is nothing to sneeze at.

UPL's hedges as of December 12, 2013 are in the table below.

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Currently UPL has no hedges in Q1 2014. It probably expects natural gas prices to be higher due to cold winter weather. It has 100.6 Bcf of natural gas hedges at $3.89/mmbtu for the other three quarters of 2014. Natural gas production in Q3 2013 was 55.7 Bcf. As a rough approximation natural gas production for FY2014 should then be about 223 Bcf (4 times Q3 2013 natural gas production). Of this about 122 Bcf will be unhedged according to UPL's hedge information as of December 12, 2013. Using the same example above ($4.30/mmbtu instead of $3.70/mmbtu), UPL would have approximately +$0.60/mmbtu * 122 million mmbtu = $73.2 million more in revenues. These monies would flow directly to the bottom line after taxes, etc.

To put this in perspective UPL's adjusted net income for Q3 2013 was $57.9 million. If you guesstimated that the above $73.2 million was about one third less after taxes, etc. You wind up with about $49 million more in adjusted net income for the 2014 year. This is almost one extra quarter's worth of adjusted net income (using Q3 2013 as the base case). That is a nice Christmas present from Santa.

Rosetta Resources recently issued FY2014 guidance for production of 60-65 Mboe/d. Using the mean, this comes out to 62.5 Mboe/d * 365 days = 22,813 Mboe for FY2014. This production will likely be close to the Q3 2013 distribution of 65% liquids and 35% natural gas. 35% of 22,813,000 Boe is 7,984,375 Boe, which is 5.8 mmbtu/Boe * 7,984,375 Boe = 46,309,375 mmbtu.

ROSE has 80 * 1000 mmbtu/d of hedges for natural gas. Of these only 30 * 1000 mmbtu/d are swaps at $4.07/mmbtu. The collars are two way collars at a top of $4.94/mmbtu and a floor of $3.60/mmbtu. These latter hedges only provide minor protection to the far downside; and they only restrict profits to the far upside. Hence I will treat them as unhedged for the purposes of this estimate. The 30 * 1000 mmbtu/d * 365 days = 10,950,000 mmbtu can be subtracted out of the above calculation (i.e. those for the swaps at $4.07/mmbtu). The difference between the two prices mentioned far above for FY2014 natural gas production is $0.60/mmbtu. $0.60/mmbtu * (46,309,375 mmbtu - 10,950,000 mmbtu) = $21,215,625 in extra revenue for FY 2014.

With mostly oil and NGLs production, ROSE will not benefit as much as CHK or UPL It had adjusted EBITDA of $455.3 for the first nine months of 2013. The approximate $21.216 million will add to this; but it will not amount to a huge percentage change. For both CHK and UPL the significance of the higher natural gas prices is much greater.

All three of these stocks are worthy of investors attention. However, CHK and UPL will benefit more from the recent rise in natural gas prices. If you consider that this year is supposed to be a colder year than normal (Farmer's Almanac). Natural gas prices might continue to rise. Look at what happened last year in a "normal winter" in the chart of Henry Hub Spot Prices.

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At this time last year Henry Hub Spot Prices were about $3.40/mmbtu. They climbed all winter from there to about $4.38/mmbtu on April 19, 2013. There were no unusual natural gas events that I remember. That's about a +$1 price climb over a normal winter. If we see a +$1 natural gas price climb from the closing Nymex price of $4.46/mmbtu on December 19, 2013 by April 19, 2014, that will translate into April 2014 natural gas prices of about $5.40/mmbtu. I am not saying this will happen, but it could.

Remember export of LNG (liquefied natural gas) is scheduled to begin in late 2015 or early 2016. By mid-2014, the start of that will not be far away. Further UPL sees U.S. natural gas demand rising 14.62 Bcf/d from 2013-2015. This may put significant upward pressure on natural gas prices. If this happens, investors can see from the above calculations that both CHK and UPL should profit handsomely from the upward trending natural gas prices. For long term investors this is an even better play. LNG exports are expected to increase rapidly from 2015 - 2020. They should provide continuing upward pressure on U.S. natural gas prices.

The two year charts of CHK and UPL provide some technical direction for this trade.

The two year chart of CHK is below:

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The slow stochastic sub chart shows that CHK is near overbought levels. The main chart shows that CHK has been in a strong uptrend for most of 2013. This uptrend shows no sign of failing. CHK has been going sideways lately, but that may just be a prelude to another strong move upward. With a PE of 20.02, an FPE of 12.60, and an analysts' next five years EPS growth estimate of 53.85% per annum, CHK appears to be a very strong buy. When one notices that insiders have bought +5.8% more of the stock (+394,500 shares) in the last six months, CHK seems to be an even stronger buy.

The two year chart of UPL is below:

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The slow stochastic sub chart shows that UPL is neither overbought, nor oversold. The main chart shows that UPL has been trading in a sideways channel for most of the past two years. If natural gas prices are likely to go up in the future, this sideways channel is likely providing technical energy for a strong upward move. If natural gas prices climb another +$1 by mid-April, as the previous year's natural gas price chart indicates they may, then UPL will likely begin a good up movement soon. Now could be a good time to get into UPL stock.

Fundamentally UPL has no PE, an FPE of 10.08, and an analysts' next five years EPS growth estimate of 11.00% per year (27.00% in 2014). If natural gas prices continue to rise, those figures could be gross underestimates. UPL has had only a very small amount of insider buying at 0.2% in the last six months (+9000 shares). However, a small amount of insider buying is better than none or insider selling.

Both fundamentally and technically both of these stocks should go higher over time. Both should prove to be good long term investments. CHK looks like the better buy. It has huge holdings in prime oil and gas unconventional development fields. However, UPL, which is more natural gas dependent, has its own niche; and it should do well too. It is a very low cost natural gas producer; and that alone should make it a great investment for the future.

NOTE: Some of the above fundamental fiscal data is from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CHK over 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.