Chesapeake Increases Hedging as Gas Bull CEO Readies Exit

Chesapeake Energy Corp. (CHK) is hedging half its 2013 natural gas production less than a year after almost running out of cash because the outgoing chief executive officer failed to protect against falling prices.

Chesapeake, which posted its largest fourth-quarter profit decline since 2008 today, locked in prices for 50 percent of this year’s gas output and an even larger proportion of expected crude production, Chief Financial Officer Domenic Dell’Osso said. As recently as December, the company said it was “largely unhedged,” leaving 2013 gas supply exposed to price swings.

The effort to stabilize future cash flow marks a strategic change just three weeks after Oklahoma City-based Chesapeake announced the imminent departure of CEO Aubrey McClendon from the company he co-founded and ran for almost a quarter century. McClendon exited gas hedges in late 2011 amid forecasts for a weather-driven spike in demand and prices that never happened, exposing Chesapeake to collapsing prices that forced the CEO to sell assets and increase borrowing.

Chesapeake “capitulated” by hedging after avoiding or minimizing their use for so long, David Tameron, a Denver-based analyst at Wells Fargo & Co., said in a note to clients today. “We view the move as positive as it should help protect cash flow” if North American gas supplies continue to grow faster than demand.

Hedges are financial instruments such as swaps and futures contracts that commit an energy producer to exchange a portion of output for a fixed price by a certain date. Chesapeake, the largest U.S. gas producer after Exxon Mobil Corp. (XOM), lost $2.1 million a day last year as gas plunged to a decade low, too little to justify the costs to drill some of the company’s biggest deposits in Texas and Louisiana.

‘Not Happy’

Chesapeake said on May 1 the company was in danger of running out of cash in 2013 without a rebound in gas prices and billions of dollars in asset sales. That month, the company took a $4 billion short-term loan from Goldman Sachs Group Inc. and Jefferies Group Inc. The company failed to reach its 2012 goal of $13 billion to $14 billion in asset sales.

McClendon said on a May 2 conference call that the company was “not happy” with the decision to exit its hedged position in late 2011. “If we had to do it all over again and with the hindsight of winter, we would have obviously done something different,” he said.

During a Dec. 4 presentation, Senior Vice President Jeffrey Mobley said estimated 2013 gas production remained largely unhedged because the company believed prices were poised to increase. At some point in the past 11 weeks, Chesapeake executives decided to abandon their plan to face the 2013 gas markets without substantial hedges in place.

‘Short-Term Protected’

“The short-term impact of commodity prices won’t have the impact that it did have on us last year,” Dell’Osso said during a conference call with analysts today. Being “short-term protected while still being long-term bullish I think makes sense.”

On those occasions when Chesapeake has turned to hedging, its record has been mixed. The company posted a 36 percent drop in fourth-quarter profit to $300 million today as hedges locked some of Chesapeake’s gas output in to below-market prices.

Chesapeake received an average price of $2.07 per thousand cubic feet of gas during the last three months of 2012, a 47 percent decrease from a year earlier, according to a company statement.

The earnings announcement followed the release of an internal inquiry into McClendon’s use of private stakes in company-owned wells to borrow more than $800 million from some of the company’s biggest financiers. The review found no intentional misconduct on the part of McClendon.

Fracking Pioneer

McClendon agreed last month to retire from the company he co-founded in 1989. He was one of the pioneers of the horizontal drilling and hydraulic fracturing techniques that triggered a renaissance in U.S. energy supplies, eventually leading to a drop in North American gas prices.

The 53-year-old CEO came under scrutiny in March and April last year amid revelations that he’d used personal stakes in thousands of company-owned wells as collateral for more than $800 million in private loans. He was stripped of his chairmanship in June.

No successor CEO has been named yet. McClendon agreed to remain with the company through April 1 to smooth the transition to a new leader, despite “philosophical differences” with the board, according to a Jan. 29 statement.

Chesapeake has hedged about 50 percent of projected gas production this year at an average price of $3.62 per million British thermal units, according to today’s statement. The company has hedging contracts in place for about 85 percent of the year’ oil output at an average price of $95.45 a barrel.

More Production

Chesapeake boosted gas output by 2.9 percent during the last three months of 2012 to 280 billion cubic feet, according to the statement. Crude output from the company’s wells jumped 69 percent to 8.94 million barrels for the period and production of natural gas liquids such as propane and butane increased by 3.5 percent.

Gas comprised 77 percent of Chesapeake’s output during the fourth quarter as the company pumped more crude, down from 82 percent a year earlier.

Chesapeake fell 0.3 percent to $20.19 at the close in New York.

To contact the reporter on this story: Joe Carroll in Chicago at jcarroll8@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net

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