Sunday, August 3, 2008

Chesapeake Keeping Spotlight on Natural Gas

Aug. 2--Chesapeake Energy Corp.'s unrealized hedging loss of $3.4 billion during its second quarter raised more than a few eyebrows this week.

Simply put, the company encountered the loss -- really, just on paper -- because natural gas was selling for more than the price the company locked in with its delivery contracts during the time.

Hedging, company officials admit, is a difficult concept to grasp, especially for people who work outside the energy industry.

Jeff Mobley, Chesapeake Energy Corp.'s senior vice president for investor relations and research, told The Oklahoman he had spent much of his day Friday on the phone, explaining how the company's hedges work.

Simply put, the company has a loss on its hedging contracts when the market price for natural gas and oil is more when the contract matures than what the company agreed by contract to sell it for.

Yet, the company encounters gains on its hedging contracts when the market price is less when delivery is due than what the company agreed by contract to sell it for. In fact, Chesapeake said it's made up what it lost in the second quarter.

Between the end of the second quarter and July 25, for example, Chesapeake made enough money on its contracts to have gains of more than $4.7 billion, because the price of natural gas had fallen below the company's agreed sales price to a buyer.

The company deliberately hedges, in fact, to minimize the effects natural gas' price changes have on its bottom line.

Chesapeake hedges a great deal of gas over a long period to lock in guaranteed cash returns during that time, which gives it the ability to plan out its operations. The company expects it will gather substantially strong profit margins on its hedged production for the better part of the next three years, officials say.

Looking ahead Aubrey McClendon, chairman and chief executive of Chesapeake, said Friday during a conference call that Chesapeake is able to keep its finding costs low in part by finding partners in new fields.

The company, for example, sold 20 percent of its mineral acres in the Haynesville Shale natural gas field to Plains Exploration and Production Co. for $3.3 billion, and McClendon added the company is looking for partners in the Fayetteville and in the Marcellus Shale natural gas fields.

Through these ways, Chesapeake has created a process that leads to higher profitability and greater returns on capital, he said.

McClendon also updated analysts on the company's activities in each of its major fields.

He specifically noted growing production in the Barnett Shale natural gas field in north Texas, the Fayetteville Shale natural gas field in Arkansas and the future of the Marcellus Shale natural gas field in the Appalachia Basin.

"There are way too many regulatory, topographic, water and infrastructure issues that will keep Marcellus from making a meaningful contribution to our country's gas production until at least the 2013 to 2015 timeframe," McClendon said.

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