Posted by: Simon Lack | January 23, 2012

Chesapeake Responds to Market Forces

To make any money in natural gas E&P stocks you need to look carefully at balance sheets and production costs. Natural gas prices have been collapsing because of oversupply and a mild winter. The success of shale drilling is hurting many natural gas E&P companies whose activities have led to an abundance of cheap gas.

We’ve never owned Chesapeake Energy (CHK) because we’ve always felt that Aubrey McClendon has a bigger risk appetite than we do. But he’s shown some financial discipline in today’s decision to curtail natural gas production. The old saw that the cure for low prices is low prices is in action.

While we don’t own CHK, we have recently been adding to other E&P names that we like. Range Resources (RRC) is among those. If natural gas is being sold at prices that make continued production uneconomic for the industry, only those with the lowest production costs can be expected to benefit. Below is a slide from RRC’s recent presentation (originally created by Gooldman Sachs) which reveals which companies have the lowest costs of production. The Marcellus Shale in SW Pennsylvania has the lowest costs in America, and the slide indicates that even natural gas at $2.50 can still be profitable for those that drill there. RRC is the purest bet on that region. The financial discipline shown by CHK is good for their shareholders but great for companies who can afford to maintain current levels of output.

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