Chesapeake Energy Doesn’t Always Cash in When Natural Gas Prices Rise

NEW YORK (TheStreet) -- Chesapeake Energy (CHK) is the second-largest natural gas producer in the U.S. In the past three quarters, almost 40% of its revenue from production came from natural gas. However, Chesapeake's realized natural gas prices are much lower than market prices. This suggests that investors who think the natural gas market will heat up may not reap the rewards by investing in Chesapeake. 

The table below shows the realized prices of natural gas (these prices account for realized gains/losses from derivatives but not unrealized gains/losses) as recorded by Chesapeake and the average quarterly prices of natural gas during the first three quarters of the year.

 
Source of data Chesapeake's Web site and EIA

The company's realized prices tend to be well below the average quarterly market prices of natural gas. By comparison, Anadarko Petroleum (APC) , another oil and natural gas producer in the U.S., had a third-quarter average sales price of $3.62 -- only 8.6% lower than the average quarterly market price.

The recent earnings report showed that Chesapeake's adjusted net income reached 38 cents per share, 5 cents higher than the consensus among analysts. This higher-than-expected figure was driven by a slightly better-than-expected gain in production -- the company's output reached 66.8 million barrels of oil equivalent due to higher yield in natural gas liquids.

One of the reasons for the disparity in realized prices is Chesapeake's hedging scheme to protect against a potential fall in natural gas prices, which includes a three-way collar. Under this type of hedge, the company set a ceiling and a floor price. This means Chesapeake didn't cash in on the high price of natural gas for a sizable portion of its production.

Another factor to consider is basis discounts at certain delivery points as explained by the company in the second quarter:

...Chesapeake and other natural gas producers in the Marcellus shale experienced significant weakening of natural gas price differentials relative to the Henry Hub benchmark natural gas price. At certain delivery points during the 2014 second quarter, particularly Dominion South, Tetco M3, TGP Zone 4 and Transco Leidy, the company experienced basis discounts to Henry Hub prices between 92 cents and $2.32 per mcf, which was significantly wider than forecasted.

According to one report, the company was subpoenaed by the U.S. Department of Justice to provide information on its royalty payments practices to mineral proprietors. Time will tell if this issue develops any further and whether it could have an adverse impact on the company's stock.

In any case, investors should be aware of this high disparity between realized and market prices that Chesapeake experience. This could suggest that even though natural gas prices are heading up, the company's revenue from natural gas are not.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary from an outside contributor, separate from TheStreet's news coverage.

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