Chesapeake Energy: Maintaining ‘Sell’ In Light Of The Natural Gas Price Expectations

Chesapeake Energy (NASDAQ:CHK) investors had a disappointing 2023, including the last few weeks. Warmer than normal temperatures recently and the report last week of a delay in the Gold Bass LNG terminal project caused a continued drop in natural gas prices. CHK stock price has dropped about 15% since I downgraded CHK in September to a sell. This is an update to prior articles.

CHK and S&P 500 ETF Price Change Since Sept 6 Article

Continued Share Repurchases

I want to start with an issue that I covered in my prior article. Chesapeake Energy is in a capital-intensive commodity-based industry that is very risky, but they continued to make stock repurchases in 3Q. As I covered before, I think management should use this cash to pay down debt to reduce risk or to enhance CAPEX.

Share Repurchases 2023 and 2022

They already “lost” $221 million on their repurchases. The current market value of their CHK repurchased shares is $1.157 billion compared to a total repurchase amount in 2022 and 2023 of $1.378 billion with an average repurchase price of $89.40 ($74.95 current CHK price).

Becoming Very Dependent on LNG Exports

Many investors buy/hold CHK for the LNG potential. That expectation was negatively impacted last week when it was disclosed that the opening of the Gold Pass LNG terminal in Texas would be delayed until the first half of 2025 instead of late 2024. The reality is that major construction projects often have delays and I would not be surprised if there were encourage delays. The importance of the export facility was even discussed during the latest conference call when management stated they were planning on increasing their number of rigs in their Haynesville from 5 to 6 in the second half of 2024 “if that looks appreciate it’s (the new LNG export facility) going to play out and the strip looks appreciate it’s going to hold up”.

On October 31 it was announced that CHK signed a 15-year LNG preliminary, non-binding accord with Vitol for up to 1 million tonnes of LNG per year starting in 2028. Last March they announced a preliminary, non-binding accord with Gunvor for up to 2 million tonnes per year starting in 2027. (One million tonnes of LNG is approximately 48.7 Bcf of natural gas.) While these deals might be considered major positive developments, I worry about the pricing. The pricing is based on the Japan/Korea Market – JKM Index. This is the benchmark for the Asian LNG market, but if there is some natural gas glut, for whatever reason, in that area and at the same time there are production/pipeline issues in Haynesville, this could turn out to be a major problem. I would prefer long-term agreements that include both costs/expenses and market price variables when determining the purchase prices. One-sided long-term agreements are too risky, in my opinion.

One of the problems with large exposure to the LNG market is that there are now many more geopolitical and international economic issues that directly impact CHK, which adds additional risks for investors. Years ago, before the U.S. exported LNG these risks were just indirect. I expect some of their LNG exports will also be associated with TTF – Title Transfer Facility, which is the pipeline pricing index and is often used when pricing LNG products in Europe. So, CHK investors have to now worry about the weather in Europe and Asia, in addition to the U.S. In addition, there are transportation issues such as the impact on shipping via the Panama Canal that is currently having major problems.

Currently, there is a significant price difference between U.S. natural gas prices and those in Europe and much of Asia, which makes the LNG market so attractive. That does not, however, mean those differentials will continue long-term. I think the political hostility against using fossil fuels is much stronger in most of Europe compared to the U.S. The reality is that the LNG market could be severely impacted if the various Green Parties in Europe eventually win enough seats and force the banning of fossil fuels or even major reductions in their use.

Indicative of how important the LNG market is to their future, Chesapeake bought a 35% equity interest in Momentum Sustainable Ventures which is in the process of building a gathering system/pipeline to the Gulf Coast from Haynesville. According to their recent update the total investment for 2023 in this deal is estimated at $285 million to $315 million. The project is expected to become operational in late 2024.

NG3 Project

Natural Gas Prices – Weather Is Everything (Almost)

If you were building a complex econometric model to forecast natural gas prices, the weather would be one of the most important variables – current temperatures, differences from average, and short-term and long-term temperature forecasts. Currently, and over the last six weeks all of those temperature metrics have been negatives for natural gas prices in the U.S. and much of Europe, which has resulted in plunging Henry Hub prices. Lower-than-normal natural gas usage has resulted in higher-than-normal natural gas storage, which overhangs the market even if temperatures get back closer to normal later this winter.

January 2024 Henry Hub Futures Price

While Henry Hub prices are often used by investors, Chesapeake’s Marcellus production is sold into the northeastern U.S. market and there is often a significant price difference.

Many of the regional spot natural gas prices are currently fairly close to the prices in my September CHK article. Some of the regional prices rose significantly during October when there were lower-than-normal temperatures but then fell as the weather was warmer than normal in November and December.

Sept. 1, 2023

Prices in Europe as measured by the Dutch TTF futures January 2024 contract have also dropped sharply since the end of October.

January 2024 Dutch TTF Natural Gas Futures

(Prices: Euro cents per MWh)

I keep reading forecasts that because of El Niño the weather this winter will be warmer and wetter than normal. Trading energy stocks based solely on weather forecasts, in my opinion, is not investing – it is gambling. Instead of looking at future weather forecasts, I prefer to look at a known metric and that is current natural gas underground storage. The current storage is near the five-year maximum, which could mean that even if weather becomes more normal later this winter there is a significant amount of gas already available to help supply that demand.

Hedging Against Price Declines

Chesapeake often hedges a significant portion of its expected future production. For 4Q 2023 they are 70% hedged with a $3.54 mmbtu floor and $5.01 ceiling so the impact of recent lower prices will not be as great if there were no or very little hedge positions. What I find surprising, however, is the very modest amount of new hedges that were added between 8/1/23 and 10/26/23 as can be seen by the chart below because prices were relatively strong in October.

Hedge Positions

Because CHK uses extensive hedging it is really not the best stock to trade forecasted natural gas price changes. Often energy trusts, which can’t hedge, are more sensitive to price changes. These trusts usually have implied natural gas and/or oil call options built into their current market values.

Recent Results – 3Q 2023

Chesapeake’s 3Q results represent a critical issue that too often investors ignore. An energy producer can have top-tier assets, which Chesapeake has, and still report mediocre results if prices are weak. Because there has been such a dramatic change in their core assets over the last few years with the purchase of Marcellus assets and the recent sale of Eagle Ford assets, which had some oil production, comparing prior long-term results to current figures is not really relevant when valuing their current operations.

3Q and Nine Months Income Statement

3Q and Nine Months Adjusted EBITDAX

3Q Average Daily Production and Prices Received

Conclusion

I am continuing my sell recommendation on CHK because I think the stock could drop a few more points before it becomes a hold. These are the major reasons why CHK could continue to drop: 1) I expect natural gas prices to remain weak because of El Niño and because I expect a resolution in the first half of 2024 to the Russian/Ukraine war. 2) LNG exports most likely will be a short-term positive, but because of geopolitical pressures, the long-term outlook for fossil fuels is very negative, especially in Europe. 3) I feel that management is not properly managing their balance sheet by repurchasing stock instead of reducing risk by paying down debt.