During the first quarter of 2014, the oil and gas market heated up. Despite these developments, shares of Chesapeake Energy (NYSE: CHK) didn’t perform well and lost nearly 1.5% of their value during 2014, up to date. But has it performed so badly in the past quarter? In anticipation for the company’s earnings report for the first quarter, which will be released on May 7th, let’s see what its investors should expect.
The U.S oil market heated up in first quarter of 2014 and the average quarterly price of oil (WTI) was roughly 4% higher than the parallel quarter in 2013. Furthermore, based on the company’s 2014 guidance, its oil production is expected to rise by 14% to reach 10.6 mmbbl. This means, the company’s oil revenue rose by 18% due to higher price and production.
The price of natural gas also rallied during the 2014 winter and passed the $6 mark on more than one occasion. The average quarterly price of natural gas was around $4.7. But let’s be conservative and assume the company’s realized price was around $4 (mainly due to the derivatives contracts it holds — more on this issue below). Since Chesapeake’s annual production is expected to inch down by 1% to 1,100 Bcf, its quarterly production may have declined to 270 Bcf — nearly 0.7% lower than the first quarter in 2013. Despite this modest drop in production, in the first quarter, natural gas sales were nearly 86% higher than last year.
Even though the price of NGL took a nose dive in the past several weeks, it was still mostly hovering close to the $50 mark during January and February . Moreover, the company estimated its NGL production to rise by roughly 50% to 7.4 mmbbl, during the first quarter. Therefore, even if we were to assume the average price was $40, this bring Chesapeake’s sales from NGL to nearly $300 million, which is 115% higher than the same quarter in 2013.
Finally, the company estimated its net margin from marketing, gathering and compression operations to drop to $62.5 — nearly 37% lower than last year. In 2013, this business segment’s operating profit was only 1%. Moreover, this segment’s profitability is likely to be even narrower this year, which is likely to have very little impact on Chesapeake’s earnings.
Keep in mind, the numbers listed above should be taken with a grain of salt for two main reasons: Winter conditions and derivatives contracts.
The extreme winter conditions have most likely cut down the production in parts of the U.S such as Eagle Ford Shale in South Texas and Northern Marcellus Shale in Pennsylvania: The weather conditions already set their toll on the Eagle Ford Shale during the fourth quarter of 2013 as the production dropped by 8% from the third quarter. The poor weather conditions throughout the U.S could have reduced the production of oil and natural gas so that the company might not meet its 2014 guidance.
The other factor to consider is the derivatives contracts the company had purchased in order to limit its exposure to fluctuations in the energy market. Last year, Chesapeake acquired options and future contracts to protect against a sharp fall of natural gas and oil prices. Since these options are very expensive the company reduced this insurance cost by setting a ceiling for the prices of oil and natural gas — i.e. wrote call options. But only a portion of the company’s oil and gas output is hedged with options. Because of this ceiling, which is set at $4.39 for natural gas in the first quarter of 2014, Chesapeake didn’t fully benefit from the rise in natural gas prices. Therefore, for the first quarter of 2014, the average realized price of natural gas was lower than the quarterly average price of natural gas of $4.7.
The bottom line
I think Chesapeake might not meet its production guidance on account of the harsh weather conditions. Nonetheless, the high prices of oil and natural gas are likely to more than offset any drop in production. Therefore, the company is likely to show a rise in revenue and improve its profit margins in the first quarter.
For further Reading:
- Why the Recent Rally in Natural Gas won’t help XOM
- Is Chesapeake walking towards the right path?
- Will Oil Come Down?
- Is This Oil Company Recovering?
Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.