The recent recovery of natural gas hasn’t passed by Chesapeake Energy (NYSE: CHK). Shares of the company rose by 16% since the beginning of the year. The company is not out of the woods just yet but will its shares continue to rally as the year will progress? Will Chesapeake’s upcoming first quarterly financial reports disappoint its investors? Let’s further explore these issues.
Let try and answer these questions by taking a close look at the recent developments in the natural gas and oil markets – Chesapeake’s core business.
Natural gas is making a Comeback
The tumble in the price of natural gas during the first half of last year didn’t repeat this year. Moreover, this year the colder than normal weather and the tropical storms that hit the East Coast may have all contributed to the recovery of price of natural gas. The demand for natural gas in the residential/commercial sectors that account for roughly 40% of the entire U.S demand rose during the first quarter of the year. Thus, during the first quarter of 2013 the average price of natural gas was $3.47/mcf compared to an average sales price of $1.77/mcf that Chesapeake received for its natural gas it sold in 2012. The average price of natural gas during 2012 was $2.17. Considering the ratio of sales price to average price of 63% – this means that Chesapeake’s natural gas sale price in the first quarter of 2013 might be around $2.17/mcf, which is still much higher than last year’s price – nearly 27% higher than the price in the first quarter of 2012. So at least in this front Chesapeake is likely to outsell last year’s natural gas sales. Nonetheless, the share of natural gas out Chesapeake’s total sales tumbled down from 60% in 2010 to 16% in 2012. This low share is likely to rise in the first quarter of 2013 but won’t come close to the high rate recorded in 2010. So the effect the rally of natural gas has on the company’s total revenues is likely to be small.
Despite the drop in natural gas prices last year, the company’s natural gas production grew in 2012 by nearly 12.4% (y-o-y). The recent asset sales the company made in recent months is likely to pull down the company’s volume of production. In its recent yearly outlook, the company’s volume of natural gas production will reach 1030-1070 bcf, which is between 5% and 9% drop.
Chesapeake isn’t alone in cutting its natural gas production. Other oil and gas companies also reduced their natural gas production and the low price of natural gas is likely to keep these companies’ natural production lower than in previous year: Devon Energy (NYSE:DVN) one of the leading natural gas producers cut in 2012 its natural gas production by 2% (y-o-y). This reduced the company’s natural gas sales by $52 million in 2012. The net natural gas revenues fell by 35% during 2012 – mostly due to the price drop. Share of natural gas out of total revenues also fell from 36% in 2010 to 23% in 2012. Even if this company will also reduce its natural gas production, it will still have a better year than it had in 2012.
Anadarko Petroleum (NYSE:APC), another leading oil and gas producer, has also suffered from the drop in the price of natural gas during 2012. According to the company’s financial reports, during 2012, its revenues fell by 4%. Most of the drop was also due to the drop in the price of natural gas: The Company’s natural gas revenues fell by almost 26% (y-o-y). But for Anadarko, unlike Devon or Chesapeake, the share of natural gas was much lower even before the crash of natural gas prices in 2012. Share of revenues in natural gas fell from 23.6% in 2011 to 18% in 2012. So the effect natural gas had on its revenues was smaller than it was on Devon or Chesapeake. Let’s move to oil.
Oil Remains Stable
Despite the high volatility of the price of oil during the first few months of 2013, its average quarterly rate was $94.4 bbl, which is almost the same annual average price in 2012 but 8.3% lower than the rate recorded in the first quarter of 2012. For Anadarko, the revenues from oil accounted for nearly 65% of its total revenues in 2012. So the price effect might have an adverse effect on most of the company’s revenues compared to the same quarter in 2012. For Devon or Chesapeake share of oil sales out of total revenues in 2012 was around 30%. Therefore, the drop in price of oil is also likely to adversely affect the revenues of Chesapeake. But based on the company’s outlook its oil production in 2013 is expected to rise by roughly 18% (y-o-y) so the drop in price of oil will be eliminated by the rise in production.
Based on the above, I think that these companies including Chesapeake will have a better first quarter of 2013 than they had in 2012. Moreover, if the price of natural gas will remain above $4/mcf and the price of oil will remain over $90 bbl, Chesapeake will have a much better year than it had in 2012. But the company’s exposure to natural gas will keep its risk high. Finally, the price of natural gas is still lower than in previous years (before 2012), which will keep Chesapeake cutting its natural gas production.
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