Low Natural Gas Price Realization Puts A Dent In Chesapeake’s Bottom Line

Chesapeake Energy‘s (NYSE:CHK) stock was up slightly despite its reported earnings per share dropping by two-thirds to $0.22/share in the second quarter 2014, from $0.66/share in the second quarter last year. ^[1] Excluding one-time items, earnings per share came in at $0.36/share, still far below the expected figure for the quarter. Even though the company posted a 10% revenue growth on the back of a 54% gain in revenues obtained from marketing, gathering and compression activities, a near 50% drop in natural gas prices due to an oversupply of natural gas in Marcellus Shale region and heavy expenditure on buying back debt securities resulted in a near 67% decline in net income for the quarter. ^[2] The company managed to increase its daily production by 12% to 695,000 barrels of oil equivalent(BOE) during the quarter, but low natural gas price realization due to an oversupplied natural gas market near the Marcellus Shale Region meant that revenues generated from the natural gas, oil and natural gas liquids businesses dropped by nearly 30%. ^[1] Because heavy dependence on fixed costs is built into its business model, CHK was unable to cut expenses incurred in the selling of these commodities. Operating expenses rose by 30% as the company relied on the low margin marketing, gathering and compression business to make up for lost revenues from the sale of natural gas, oil and natural gas liquid (NGL). Additionally, the company spent a lot of money on repurchasing debt securities as it looks to refinance its debt and pile up its balance sheet in anticipation of tough conditions in the natural gas, oil and NGL markets.

See our complete analysis for Chesapeake Energy here

We will be revisiting our price estimate for Chesapeake Energy to about $28 to account for the latest earnings. Our price estimate is about in line with the current market price.

Natural Gas Liquids Continue to Drive Production Growth

Chesapeake’s overall quarterly production grew by 12% year-over-year to around 695,000 BOE per day. ^[2] Oil production improved by around 12% and natural gas production increased by 7% adjusting for recent asset sales.  ^[2] However, NGL remained the key growth driver for the quarter, with production rising by about 72% year-over year. ^[2] This growth has come from strong production in the Utica and Southern Marcellus regions. Infrastructure has for long proved a bottleneck in the Utica shale, and the commencement of shipments on pipelines such as the ATEX  pipeline (which provides connectivity to the Gulf) during the previous quarter, provided much-needed takeaway capacity from the shale. Chesapeake’s output from the Utica shale has grown five-fold compared to last year, and natural gas liquids production has accounted for roughly 30% of its Utica volumes. Chesapeake also raised its 2014 total production growth outlook to 730,000 barrels of oil equivalent per day on the back of better NGL volumes. ^[2]

Poor Price Realizations for Natural Gas

Chesapeake’s natural gas price realizations dropped to less than half of last year’s at $2.45 per 1,000 cubic feet (Mcf). ^[2] The company had recently reported a decline in natural gas price realizations as its reported differential with the benchmark Henry Hub spot price increased from $1.08 per Mcf in the previous quarter  to $1.91 per Mcf in this quarter. The differential consists of two components: 1) a basis component, which reflects the price at which CHK sells its gas and 2) a non-basis component, which reflects gathering, transportation and other marketing costs. Compared to the previous quarter, the non-basis component of $1.30 per Mcf, is a moderate increase from $1.19 per Mcf in the previous quarter. The increase is attributable to a shift towards higher cost production areas. ^[2]  The basis component, however, went from $0.11 per Mcf premium in the last quarter to $0.61 per Mcf discount in this quarter. ^[2] This huge swing was because of two reasons- 1) demand fell considerably between the two quarters, especially in the Marcellus Shale region and 2) there was an increase in supply of natural gas compared to the previous quarter. Looking ahead, the company expects natural gas prices to remain weak in the coming quarter, before improving in the fourth quarter as a seasonal shift in demand due to the weather change takes place. As a result, CHK increased its company-wide natural gas price differential outlook to $2.10 per Mcf implied midpoint for the second half of fiscal 2014.

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1. Chesapeake 10-Q, SEC [↩] [↩]
2. Chesapeake’s (CHK) CEO Doug Lawler on Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, August 2014 [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩]