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Schork Oil Outlook: Chesapeake Energy's NatGas Bet

NatGas: The times they are a-changin’...

In September 2006 the Calendar 2007 natural gas strip on the Nymex was trading around a lofty $7.50 and the Calendar 2008 strip around $7.80. Yet these levels were not high enough to convince natural gas giant Chesapeake Energy to fully lock in production. In a Bloomberg article from September 27, 2006, a Chesapeake Energy spokesman was quoted asking, “Why give your gas away?"

As we wrote at the time (The Schork Report— 9/28/06), who knew $7.836 gas was a steal?

In hindsight, Chesapeake’s decision was prescient, kind of. Nymex natural gas averaged $7.118 in 2007, but then surged to $8.899 the following year as a result of the great energy bubble of 2008. In this vein, gas prices peaked at $13.694 in July of that year, but after the bubble popped, gas was back below $6 by December.

In 2009 gas averaged $4.159 and is currently averaging $4.539 this year. The collapse in price was the residue of a surge in supply via shale-gas production and a plunge in industrial and commercial demand that resulted from the Great Recession.

Whereas once sub $8 natural gas was considered “giving it away,” today plus $8 appears to be manna. To wit, according to a story on CNBC last week, over the last three quarters, through June 30, Chesapeake sold more than 70,000 long-dated $8-strike call options in between the years 2013 and 2020. The company has now written a total of 90,000 calls with an average strike price of $8.08.

The company is therefore making a massive bet that prices will remain below $8 a dekatherm for the next ten years. Of course the company has options (no pun intended) should their bet go awry. First and foremost they can always produce the gas, albeit at a potentially substantial opportunity cost.

On the other hand, gas prices have dropped considerably since Chesapeake wrote these options. Average prices on the Nymex in between 2013 and 2020 have dropped from $6.89 to $5.85 as of last Friday. Therefore, the company can always cover the calls by laying into the futures… but what fun would that be?

Bottom line, the company is now short (reportedly) 90,000 naked calls. That is a… ahem… sizeable guess where gas prices will be or in this case, not be, ten years hence. Here at The Schork Reportwe are bearish gas, but we are not that bearish. We wish Chesapeake the best of luck; they’re likely going to need it.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.