Loss of Clarity on Chesapeake's Peak

As crude oil has sold off over $16 (approximately 11%) in the last four days, natural gas, and the natural gas companies have also taken a hit. As of last week, natural gas prices are down over 20% since July 4, and fell over 8% last Thursday alone. Not surprisingly, Chesapeake Energy (CHK) sold off with the corrections in both crude oil and natural gas, falling almost $10, or over 15% in the last week.

Source: StockCharts.com

A little over a week ago I wrote an article about whether Chesapeake had reached a peak when it recently announced a common stock offering of 25 million shares at $57.25 per share. The news of the offering on July 8 had put some pressure on the stock. I argued at the time that the stock had probably not peaked, in part because of the link between crude oil and natural gas, and the recent bullish moves in crude. Furthermore, the CEO of Chesapeake, Aubrey McClendon, was buying stock in the open market like there was no tomorrow, purchasing over 3.5 million shares since the first of the year. Natural gas was also trading below its historical multiple to crude oil, somewhere between a 6-8 multiple. As long as crude oil did not fall below $100 per barrel anytime soon, historical multiples stay in place, and demand for natural gas stays strong, Chesapeake should be fine.

Well, what a difference a week can make. While Aubrey McClendon continues to buy shares, purchasing another 750,000 shares at $57.25, many of the other parameters and assumptions have changed (guess who bought into the offering at $57.25? - one could speculate that the CEO purchases have been holding the stock up short-term). While crude oil has not fallen below $100 a barrel, it has had a historic one week sell-off. Furthermore, the sell-off in natural gas has been just as bad, if not worse than expected. Natural gas in underground storage increased to 2,312 Bcf, registering an increase of 104 Bcf.

Given the recent price action in crude oil and natural gas, the sell-off in Chesapeake's stock, the dilution from the recent stock offering, and the historical pressure on natural gas prices in late July and early August, it would be easy to sell the stock at current levels and wait for more clarity. In fact, this may be the smart move, even at the risk of selling at a near-term bottom. Nonetheless, for now I will continue to hold what is left of my position, but look to either add or sell in the low 50s as the stock tries to find support in this area. While the recent uptrend appears broken, there is some support in the low $50s, and it will be important for the stock to hold at these levels. Otherwise, there may be a fall to the $40 or even $35 per share level, with some weaker support at $45 per share along the way.

Given his recent purchases, I would expect the CEO to continue to accumulate stock at these levels, but even his buying may be not be enough to support the stock if crude oil continues to break support and suffer the kinds of sell-offs it has recently experienced. A number of funds ratcheted up their exposure to crude oil over the last year and are now beginning to unload their positions and lock into any remaining gains. The right (or wrong) news could once again begin the selling in earnest. Nonetheless, I am still bullish on natural gas long-term. I also still believe in the story and management at Chesapeake, and I still feel that crude oil is not going back to 1990 levels anytime soon, even if the current sell-off continues. Any weather related disruptions to crude oil and natural gas would also be bullish for prices. Yet, I am not as confident in this view as I was just a little over a week ago, and will certainly be watching the price action closely.

Comments

[tntgators]

One of the largest steering factors had to do with profit taking, and options expiring. The big boys steered the stock and took their profits coming and going. I believe one could almost ignore the past weeks as all energy stocks saw the same action. $70+ cleared the upper hurdles and low 50's cleared the other. The fundamentals have not changed and they make good money at $10.50 and they have billions of dollars sitting in the ground.

[trader tony]

Sure there might be some downside due to profit-taking or other motives, but shorting CHK would constitute near insanity. With even the slightest bit of good news (e.g. Haynesville blowout numbers, earnings, NG futures surging, tropical storms, etc., etc.) shorts will get burned... badly.

Look... there's just no way CEO McClendon is buying up shares in the open market on a whim and a prayer. This guy is pretty much universally considered one of the best CEOs in the country. He knows what he's doing.

Hence... all the recent capitalization activity (partnering up and selling off) along with McClendon's buying up large quantities of shares should tell you the Haynesville find is going to be HUGE.

Natural gas is a winner and CHK is atop the heap.

Patience on the part of longs is in order here; shorts are fully justified in any nervousness they should be feeling.

JMHO

[jakedeez]

The trend is not broken... not the longer term trend anyway. The shorter term, six month spike may give some up, but that isn't a function of the stock it is a function of the futures. They are pulling NG out of the ground at 2-3 bucks, they are the most active hedgers out there for a reason... their reserves are growing at a crazy rate.

There is nothing wrong with your suggestion of being on the sidelines, because it could come down to the mid 40's if oil breaks to maybe 100-115... but even with oil at 50 they will still be supplying an increasing percentage of the US grid power gas. (they may go this year from 1-2% of the total grid)

Also realize, even if gas were to collapse down to say $5, the major costs of drilling have been paid. Their future pumping costs will be much less, and they can convert unproven reserves to proven reserves to back out any effects from the drop in the spot prices.

They will continue to pay down debt, and beat earnings. Personally, I have puts on the XOP against my CHK position, and couldn't feel safer.

[wannaBillion]

One thing you are also forgetting is the new Marcellus Shale play extending from W.Va to N.E. PA. I live in this area, and just leased 200 of my acres to CHK. Is the Marcellus Shale a secret? This play is going to be more huge than the Haynesville Shale play and CHK is one of the biggest, if not the biggest, player in this field. Invest in CHK, guys. You are coming in at the bottom of what appears to be the most important find in the U.S. CHK is right there in front. Aubrey, if you are reading this, congratulations! You definitely are the most amazing CEO of any company out there...you sly fellow!

[motherbird]

As of Fridays close, the S&P 500 market cap weightings of energy and financials were 14.45% and 14.84% respectively.

November of 1980 was the all-time high of energy with a weighting of 29.24% of the S&P 500. Its interesting to note that that same month and year saw the all time low for financials with a weighting of 4.49% of the S&P 500. Their weightings moved in the opposite directions over the next 23-25 years with energy bottoming at 5.31% in 2003 and financials topping at roughly 25% in 2005. Thier weightings move opposite each other over 20 something year cycles and reach extremes at the turn of those cycles.

It appears to me there is much market cap yet to be destroyed in financials. Likewise energy's market cap weighting would have to double from here before it reaches its historical extremes.

[simpkins]

A true "waffle" describes this article. After I read it I didn't know if he was saying "BUY" or "SELL".

[PA GASLeasee]

CHK is currently sandbagging on Marcellus.....it is huge! They are trying thier best not to drive interest in this play but soon enough it is going to blow up and the cat will be out of the bag. It is a little tougher going in PA than it is in the barnett and haynesville but the shale is 3 times as thick and some test wells have blown the pipe with the pressure....they have gone to a higher pressure piping just to handle it. They are also getting big numbers with just a vertical drilling, which is much cheaper to do....they may not need to go horizontal for a while based on the initial test wells.

[bindlepete]

Cooking the Books?

I wonder if the Presidents Group on Markets - the so called Plunge Protection Team is again interfering in open markets like the NYMEX relative to the future price of oil and thus forcing oil or natural gas contracts down. No reason why they wouldn't as a dollar spent here will amplify in it's impact on the equities markets.

I short cheaper than manipulating the equities markets as they have in the past. Furhter they could use SPR as a back up for sales.

It seems all they want to do is get out of town on an up tick.

Be well

[coach Zack]

I still want to see someone talk about the "solid methane" in the Gulf of Mexico. It would be nice to burn only natural gas. I tried to e-mail Cramer but he is pushing coal more than gas. He claims to do homework but apparently not the right kind. The gas in the Gulf could fuel our entire nation for over 100 years and there is no heavy metal problem for the air. If you are interested Google "methane solid" and see what is possible.

[gokou3]

simpkins, i agree with u, especially after reading this line:

"for now I will continue to hold what is left of my position, but look to either add or sell in the low 50s as the stock tries to find support in this area"

Did he mean using a "long straddle" option strategy? I doubt it..

[racerz]

I've been in this game for 45 years buying, selling, holding, and even some day trading a few times. Never have I seen a market so absolutely crazy and I'm near 60 years old. I'm bullish on BTU and CHK at these prices, and have added to positions the last two weeks. I don't care if BTU and CHK fall further, becuse the longs are going to be partying this winter when reality comes home to roost. If BTU or CHK raises its dividend (BTU's earnings tremendous), the shorts/puts will go scurrying quicker than expected.
I also like ACI, and have added to my energy heavy portfolio with this one,too, as I have with Freeport - FCX (yes, pricey but great stock) and ABX in the metals sector.
Thus, you all know what I think is coming--and again, let the prices fall and I'll keep buying. Gas, coal, gold -- we're going to be fine.