Will The Rise In Natural Gas Curb The Fall Of Chesapeake?

May.23.12 | About: Chesapeake Energy (CHK)

The price of natural gas continues to recover: The short-term future price has reached its highest level since the end of January 2012. This price hike in natural gas is also reflected in the spike in United States Natural Gas (NYSEARCA:UNG). Will this rise in natural gas help curb the fall of Chesapeake Energy (NYSE:CHK)?

Chesapeake has been on the news lately, mainly due to the downgrade in the company's stock following the $4 billion short-term loan the company had taken at an 8.5% rate to stay afloat.

During April and May, the price of natural gas bounced back from its tumble during the first quarter of the year. During May, the Henry Hub short-term future increased by 15.8% and the price of United States Natural Gas rose by 17%. The natural gas storage levels are still high (the natural gas weekly update will be published by EIA tomorrow), even though the injections are below last year's injections; I still think natural gas prices won't keep their upward trend for long, but let's assume for now natural gas will continue to trade up. Will this rise curb the downward trend of Chesapeake Energy? After all, Chesapeake is the second-largest natural gas producer in the U.S., so there should be some strong positive effects on the recent rise in natural gas prices.

This analysis should be taken with a grain of salt because it isn't an evaluation, only a short analysis. The long-term futures of both natural gas and oil should be used for an evaluation, but since this isn't an evaluation, I'm using the short-term prices as proxy here.

The chart below shows the changes of CHK stock and the short-term natural gas price during the year (up to now):

Click to enlarge image.Click to enlarge

As seen in the chart, despite the rise in natural gas prices during recent weeks Chesapeake's stock price continued to decline.

According to the company's financial reports, during 2011 the share of natural gas out of the total natural gas and oil related revenues was 53%; oil represented nearly 47%. This means oil and natural gas are almost equal parts. Keep in mind that the revenue for Chesapeake from natural gas and oil makes up roughly 50% of the company's revenues (the other half is from marketing, gathering and compression).

Despite the rise in natural gas prices, the effect of oil prices is nearly as important. During the past several weeks oil prices declined; during May, oil prices fell by 12.6%. This means the fall in oil prices is canceling some of the rise in natural gas prices.

From the perspective of price analysis, the linear correlation between the daily percent changes of Henry Hub (short-term future) and Chesapeake's stock is 0.21; this means that the natural gas price can explain, at best, 4.4% of the volatility of the Chesapeake's stock. The linear correlation between oil prices (NYSE:WTI) and Chesapeake's stock is 0.23; this means that the WTI price can explain, at best, 5.3% of the volatility of the stock.

Therefore (under certain assumptions), nearly 90% of the volatility of the Chesapeake's stock is coming from other considerations than oil and natural gas price fluctuations -- e.g., the recent stock downgrade, the cash flow problems. This means that even if natural gas prices continue to increase in the weeks that follow, it doesn't guarantee curbing the fall of Chesapeake's stock -- especially if oil prices continue to decline.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.