Chesapeake Energy Takes a Loss on Derivatives
Tuesday, May 03, 2011 1:51 PM

Chesapeake Energy Corp. (NYSE: CHK), reported earnings Monday after the market closed with mixed results. Chesapeake Energy is the second-largest producer of natural gas in the U.S. Natural gas has not run up in price in the manner of crude oil, but may provide a profitable long-term investment in the energy sector.

For the quarter, Chesapeake Energy reported a net loss of $210 million, or a loss of  $0.32 per share, on revenue of $1.6 billion. The loss resulted from an unrealized, mark-to-market loss of $725 million on the company's portfolio of natural gas, oil and interest rate hedges. Without the unrealized losses, net income was a positive $518 million, or $0.75 per share. The Wall Street consensus estimate for earnings per share was $0.70.

The mark-to-market requirement of hedge positions causes the reported net income from Chesapeake Energy to at times fluctuate significantly. Over the long term the company's hedges have had a positive effect on the bottom line. The press release noted that for the decade of 2001 through 2010, Chesapeake's hedging program added $7 billion to net income, on average $1.21 per mcf (thousand cubic feet) of natural gas produced. Realized hedging positions added $1.71 per mcf to the natural gas production of the first quarter results.

The most positive note of the first quarter financial results was the energy production numbers. Production for the quarter totaled 3.1070 Bcfe (billion cubic feet) per day, a 20 percent increase over the same quarter a year earlier, and 6 percent better than the production in the fourth quarter of 2010. Crude oil production -- Chesapeake calls it liquids -- increased 56 percent year-over-year and 13 percent over the fourth quarter.

For 2011 and 2012, Chesapeake Energy management embarked on with it calls a 25/25 Plan. The goal is to reduce long term debt by 25 percent and increase oil and natural gas production by 25 percent over the two year period. The debt reduction will be through the monetization of assets, selling some reserves and entering into joint ventures with cash coming in to Chesapeake. In the first quarter the company was able to retire approximately $2 billion of debt.

Another strategy for increased profitability is increased production of liquid energy products. From the current 10 to 12 percent of production as liquid energy products, the goals are 20 to 25 percent at the end of 2012 and 30 to 35 percent at the end of 2015. The relatively higher prices for crude oil vs. natural gas could be all Chesapeake needs to generate higher levels of net income.

The share price of CHK has increased 50 percent since the end of November 2010. If management can hit the goals outlined in the earnings release, investors could earn that amount again between now and the end of 2012,



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