GKM

Chesapeake Energy Called the Market's Bluff

People don't think that nat gas can go down because the companies will simply shut in the wells. However, they don't understand the economics of the producers. Producers used to get less than $1 for gas not so long ago. In fact, when I worked in the nat gas industry there was once where producers were paying people to take gas from them in the spot market because of a quirk in the pipeline system (but only for a few days).

Producers, once they've sunk millions and billions into the production, have to flow the gas. At that point their variable costs are minimal and their fixed costs are huge. They will flow and take whatever price they can get. They'll keep flooding the market with gas until it is well below where people think it can go to. Even drilling is semi-variable in cost since compared to the overhead of other costs including debt, many companies will be forced to spend the money to drill to bring on gas at even ridiculously low prices because they need to service the debt.

Otherwise what's their alternative? Not pay the interest on the debt? Sit on the assets? Sell the assets at low prices because in a low nat gas price environment no one will pay up?

So BP's purchase of a stake in CHK is something for bulls to hang their hat on. Well Shell bought out Duvernay Oil right at the top of the market after several wobbly pops during Calgary Stampede. The big guys don't know what they're doing anymore than the little ones - or maybe less so.

The producers are boxing themselves into a corner again just like they've done many times before. Boom = bust.