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Chesapeake Energy Corporation (CHK), Cabot Oil & Gas Corporation (COG), EnCana Corporation (USA) (ECA): Natural Gas, An Industry in Peril?

Chesapeake Energy CorporationOur country’s policy makers are in a rush to convert the country’s energy supply from being coal and oil based to being natural gas based. The idea is that most of the oil we use is imported from less-than-friendly governments, and coal carries with it tremendous external costs of environmental and health damages. On the other hand, natural gas is local, available and, as policy makers would tell us, a “clean fuel.” Not only those benefits, but the perception is that natural gas prices will remain at historic lows for many more years to come.

This perception of the price advantage of natural gas has some states reviewing legislation passed in those states late last decade requiring investments in wind, solar, and similar non-fossil fuel production. Led by the American Exchange Council (“ALEC”) and other right wing groups, states such as North Carolina and Texas are the leaders in that movement. Yet, the presumptions that natural gas is both cheap and clean are debatable.

Natural gas is a fossil fuel, and while its burning typically involves about half the release of carbon that coal burning emits, natural gas’ carbon footprint is still considerable. But more important, perhaps, is the amount of methane that is released upon drilling or fracking for natural gas. Methane is a far more potent greenhouse gas than is carbon, and attempts to study the overall heat trapping footprint of coal and gas find that gas’ advantage is modest at best.

If natural gas is not going to singlehandedly protect the environment, at least we will have a secure local supply of energy for the next 100 years right under our feet, right? No so fast. A detailed, 181 page report released earlier this year argues persuasively that natural gas development physically cannot create energy independence in the United States. Well, at least natural gas is cheap. Never mind that it has risen from about $1.80 per mmBTU in April, 2012 to about $4.30 per mmBTU 54 weeks later. Increased utility scale use and homogenization of world prices will auger in higher prices in the future, at a time when many billions of natural gas infrastructure have already been spent.

The natural gas producing companies have benefited mightily from the price run-up. But many remain overleveraged in what is still a low natural gas price environment. The leading company, both in terms of sales and headlines the past few years, has been Chesapeake Energy Corporation (NYSE:CHK). Over the past five years, amid self-dealing by then Chief Executive and President Aubrey McClendon, earnings have collapsed by an average of nearly 30% annually. But, with the price of natural gas on the rebound to prices not seen since summer of 2011, Chesapeake Energy Corporation (NYSE:CHK) should at the very least be profitable. The company is a shell of its former self after having divested over $10 billion in assets last year to deal with its long term debt problems. And it is not done yet, with plans to sell from $2.5 to $5.5 billion more this year.

Chesapeake Energy Corporation (NYSE:CHK) has reversed course on its disastrous decision in 2011 to leave unhedged its gas production. As luck would have it, it has locked in about 50% of its expected 2013 gas production at a price of $3.62 per mmBTU. As indicated above, gas has been selling at the Henry Hub open market price in excess of $3.62 since early March, and I do not see the price collapsing. The bottom line is that while Chesapeake Energy Corporation (NYSE:CHK) may well have a pretty good year, it likely will not be as profitable as it could be due to the hedging. Analysts are expecting $1.31 per share this year and $1.81 per share in 2014, compared to the $0.61 posted in 2012.

There are still a lot of unknowns, though related to asset sales and management changes. Until these settle down, I would still be on the sidelines of this otherwise solid turnaround story.

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