Chesapeake

Chesapeake Falls Amid Concern Over Hedging Contracts (Update1)
By Dan Lonkevich
Oct. 10 (Bloomberg) -- Chesapeake Energy Corp., this year's worst-performing petroleum producer in the Standard & Poor's 500, fell 6.7 percent in New York trading amid concern hedging contracts won't protect the company against a plunge in natural- gas prices.
Oklahoma City-based Chesapeake tumbled $1.19 to $16.52 in New York Stock Exchange composite trading. The decline, which followed Chesapeake's 21 percent drop yesterday, capped the stock's worst week on record.
Investors are concerned that Chesapeake and other U.S. oil and gas producers have hedging contracts with financial firms and other counterparties that won't be able to pay for their output at the agreed-upon prices because of the global credit crisis, said Robert Goodof, who helps manage $25 billion at Loomis Sayles & Co. in Boston.
Chesapeake also has so-called knockout swap contracts on more than one-third of its 2009 production, and those deals don't obligate the buyers to take gas when prices drop to $6.28 per thousand cubic feet of the heating and power-plant fuel, according to analyst Joseph Allman of JPMorgan Chase & Co. in New York. U.S. gas futures dropped to $6.65 today and have plunged 50 percent since the end of June.
``With natural gas close to $6.60, we think the concern about Chesapeake's knockout swaps is legitimate,'' Allman said in a note to clients. He rates Chesapeake shares ``neutral.''
Price Protection
Oil and gas producers use hedging contracts to lock in prices and ensure adequate returns from their wells and sufficient cash flow to pay off their debt.
Chesapeake spokesman Jeff Mobley said the company has contracts with more than 20 counterparties, all financial institutions. He declined to name them. Knockout swaps have served as ``prudent tools'' for the company since 2001, he said, giving it greater upside on prices.
The hedges are knocked out only if prices go below the specified price on the last trading day of the month, Mobley said. Losing that price protection could reduce cash flow, which Chesapeake would be able to manage by slowing spending.
``We are not obligated to purchase assets next year and can curtail our drilling,'' Mobley said.
Chesapeake hedged 83 percent of this year's output at $9.30. The company has 72 percent of estimated 2009 production hedged at $9.63 and 46 percent of 2010 output locked in at $9.89.
Morgan Stanley
For more information go to Oct. 10 Bloomberg