Stock of the Day - February 12, 2009 - CHK

Chesapeake Energy Corporation (CHK)

The Chesapeake Energy Corporation (CHK) is the number one producer of natural gas in the United States. Natural gas, which primarily consists of methane, currently accounts for about 22% of our nation’s energy consumption. The company engages in exploration for natural gas fields and drilling at wells that are being developed. Chesapeake has gained many competitive advantages in the natural gas sector, and future macroeconomic conditions may make the company a good long term buy.

Before we can analyze where CHK is headed, we need to take a look at the company’s history. 2008 was a year of extreme highs and lows for Chesapeake. CHK was trading at around $40 at the beginning of the year and steadily rose until it hit its 52-week high in July at $74. The increase in value was the direct result of increased demand for natural gas and rising natural gas prices: natural gas was selling for around $15 per mcf (unit of measure for natural gas) at that time.

The upsurge was short lived. Since July, natural gas has dropped to $4.50 per mcf, and CHK hit its 52-week low in December at $9.84. Since hitting the low in December, Chesapeake has bounced back up to $18.03. In order to determine the value of CHK as a company, we need to find out how it will respond to lowered natural gas prices in the short term. We also need to clarify the long-term demand for natural gas from a macroeconomic viewpoint.

It’s very important to note that Chesapeake has hedged about 82% of their gas sales at a price of $7.50. This means that even though the going rate of natural gas is $4.50 on the general markets, the company will be selling their gas to buyers at $7.50. CHK believes that it will gain 1-2 billion dollars for each of the next two years as a result of this hedge. The extra cash will be helpful while short-term macroeconomic demand for natural gas is low.

In reaction to the decrease in demand for natural gas, the company is also bringing down the number of operating rigs by 20-30%. Despite the decreased number of rigs being used, Chesapeake still estimates that it will increase production of natural gas by 5-10% in 2009. The company can maintain growth of productions because of recent acquisitions of four major natural gas fields. The gigantic fields will provide Chesapeake with growth potential for years to come.

Now we have to discuss the factors that are out of Chesapeake’s control. National and international demand for natural gas has decreased as a result of the widespread economic recession. Both industrial and residential usage of natural gas has declined. Even though the U.S. experienced an unnaturally cold winter this year, natural gas consumption did not increase. It is my belief that the demand for natural gas will remain low until at least the end of 2009 as a result of ongoing recessionary conditions… with one exception.

The exception has a name: Obama. The President has stated on numerous occasions that he wishes to decrease American dependence on foreign oil. Although he has not stated it explicitly, one way to dramatically lower our dependence on oil would be to increase our reliance on natural gas. If President Obama decides to press the issue on natural gas in an attempt to bolster the U.S. economy, shares of company’s like Chesapeake would skyrocket. Despite this, playing on the potential for government aid alone would be speculative at best.

Here’s the major point for Chesapeake: when natural gas prices begin to pick back up, they will do so dramatically. The trend of cutting back on natural gas production does not solely apply to CHK, as many other energy companies are lowering their natural gas production levels as well. So when the recession ends, and natural gas demand picks back up, supply will be very low. This is where I see money to be made: very high demand + very low supply = HIGH PRICE. It will take a while for the increase in demand to form, but when it does, expect prices to go up in a big way.

Short-term conditions will cause Chesapeake to struggle and long-term conditions will allow the company to thrive. As a result, I believe that you should wait a few months before buying CHK and allow the stock price to pull back a bit. The potential for this company in the long-run is limitless, as an economic recovery will undoubtedly cause an increase in demand for natural gas. Get in before the demand jumps, and you’re bound to make a profit.

 

-Matt Schwartz

College Trillionaire