A Surprising Winner From the Natural Gas Boom: Chesapeake Energy Corporation (CHK), EXCO Resources Inc (XCO)

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Low natural gas prices have proved to be a major burden for energy companies that derive a substantial portion of their revenue from the out-of-favor commodity. Over the past year or so, most exploration and production companies have curtailed gas drilling and shifted their focus toward oil and natural gas liquids, which are more profitable.

But one subsector within the energy industry has actually benefited handsomely from the depressed state of the natural gas market – the refiners.

Chesapeake Energy Corporation (NYSE:CHK)America’s natural gas boom
Recent advances in drilling technology applied to unconventional shale reservoirs have helped ignite what many have termed a “shale gas revolution.” Domestic production has risen steadily, from 19.3 trillion cubic feet (tcf) in 2007, to 20.6 tcf in 2009, to a whopping 22.9 tcf in 2011 – an all-time record. According to recently released data from the U.S. Energy Information Administration, production last year likely surpassed the 2011 record, with some sources estimating year-end production coming in at 24 trillion cubic feet.

Booming production from sources like Pennsylvania’s Marcellus Shale and Texas’ Barnett Shale has led to a massive oversupply of natural gas, contributing to severely depressed prices over the past couple of years. Last year, for instance, natural gas spent the entire first half of the year under $3 per thousand cubic feet (mcf), though it rose above that level in the latter half of the year.

Since most gas wells are uneconomical at under $3 per mcf gas, energy companies exited gas drilling in droves last year. For instance, EXCO Resources Inc (NYSE:XCO) cut its rig count in the Haynesville and Marcellus Shales – both prominent natural gas plays – from 18 and four, respectively, as of year-end 2011 to just five and one as of the third quarter 2012.

Chesapeake Energy Corporation (NYSE:CHK) , the second-largest natural gas producer in the country, also drastically reduced its gas-directed rig count, which stood at less than 10 as of the third quarter, down from nearly 90 in early 2011.

And Linn Energy LLC (NASDAQ:LINE) pretty much went whole hog on a highly prolific oily play, known as the Hogshooter, where it maintained eight rigs as of the third quarter, with wells posting staggering average initial production rates of around 2,100 barrels per day of oil.

With these and other energy producers turning to liquids drilling, it should come as no surprise that the total number of rigs drilling for natural gas in the U.S. fell precipitously over the course of last year, plunging by almost half. While low prices proved to be a major burden for gas producers, cheap natural gas turned out to be a major boon to refining companies.

Refiners’ changing fortunes
Geographically advantaged refining companies were big winners last year, profiting from the wide difference between the price of domestic oil and the price of global oil. Essentially, they were able to purchase cheaper domestic crude oil while selling the refined product at much higher, globally determined prices.

Fourth-quarter earnings among some of the top dogs in the sector were nothing short of spectacular. Valero Energy Corporation (NYSE:VLO) posted earnings of $1.01 billion, the highest in seven years, and up significantly from just $45 million in the year-ago period. Marathon Petroleum Corp (NYSE:MPC) reported earnings of $755 million, a drastic reversal from its $75 million loss in the same quarter last year.

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