Independent oil and gas firms are attempting to focus on the fundamentals following major allegations against one of the sector’s most colorful figures. The looming dispute over Chesapeake Energy’s chairman comes as companies already contend with a glut of natural gas production amid high prices for oil and liquids production warping traditional price dynamics.
US oil and gas company executives “talked turkey” with Wall Street analysts in New York last week at a high-level investor conference. Every spring, the industry’s exploration and production community convenes to discuss their business models and corporate strategies with the analysts who rate their company’s stock for investors.
The timing of this year’s Independent Petroleum Association of America Oil & Gas Investment Symposium was noteworthy due to cratering US Henry Hub benchmark natural gas prices – that recently dropped below $2 per million Btu for the first time since 2001 – and a breaking story that focused negative attention on one of the country’s largest natural gas producers.
The association’s members are considered “independent” because they only operate upstream – exploring for and producing oil and gas – and do not operate refining or marketing businesses. Companies that operate throughout the value chain are dubbed “fully integrated” and include the industry’s largest companies like ExxonMobil and Chevron.
Independent companies produce 82 percent of domestic natural gas, according to the IPAA website. As a result, current downward trending natural gas prices could create an overly challenging business environment for these producers were it not for one major factor, historically high oil and natural gas liquids prices.
For the past several years, many US natural gas producers have been changing their tune and billing themselves as oil producers as they seek higher returns from oil and “wet” natural gas. Wet gas is high in liquids like ethane, butane and propane, which fetch higher prices than “dry” gas.
Producing liquids-rich gas has allowed many companies to continue operating during periods of depressed gas prices that in the past would likely have resulted in companies shutting in wells due to poor economics. These price dynamics – along with many other factors – have led to an oversupplied gas market.
Coining New Terminology
Companies are touting new plays and new terminology. For example, Range Resources was promoting its “super-rich” wet gas positions. The company defines super-rich gas as containing greater than 1,350 Btu per cubic foot. The company also highlighted its positions in the “wet Utica shale, Horizontal Mississippian oil play and Cline Shale oil play.”
Range said it was achieving internal rates of return above 50% at $2 gas prices, which some in the audience found questionable. One participant remarked “there is your gas glut right there,” referring to how companies continue producing gas despite low prices. A representative from Range said IRR’s at current prices are “not typical” with regard to their entire acreage position and they are only seeing this in their best areas.
Range holds a positive long-term view of US natural gas markets and expects prices to rebound toward a range of $4.50-$5.00 per million Btu as the gas drilling rig count decreases and gas demand is stimulated by exports, the vehicle fuel market, petrochemical industry and power generators.
Management Under Fire
The IPAA conference also coincided with the release of a Reuters story that called management behavior at Chesapeake Energy into question. Specifically, the company’s co-founder and CEO, Aubrey McClendon’s role in what’s known as the Founder’s Well Participation Program, was called out for being a potential conflict of interest.
The article was published right before Chesapeake’s IPAA presentation and the topic did not come up during McClendon’s breakout session with analysts. The CEO sent a positive message, saying $2 natural gas presented an opportunity, would stimulate demand and reduce the current supply overhang.
McClendon is a long-standing, highly-vocal industry advocate and natural gas proponent. He has been on the forefront of industry efforts to promote natural gas as a transportation fuel, with numerous television appearances and public speaking engagements. He has also been a vocal defendant of the natural gas industry’s controversial hydraulic fracturing practices.
Wall Street Responds
Brokerage Sterne Agee did an about face after releasing an April 17 research note to investors with a “buy” rating on the stock. Upon release of the Reuters story, the analysts downgraded Chesapeake’s stock to “neutral.”
“Our thesis is unrelated to the quality of the company’s assets and is more a function of a groundswell of negative investor sentiment related to management’s personal loans that we feel will limit upside potential in shares over the next 12-18 months,” analysts Tim Rezvan and Ryan Mueller said in the note.
Argus Research analyst Phil Weiss was more critical and cautioned investors to avoid or sell the stock. A research note published last week went so far as to call for the ouster of McClendon and/or board of directors.
“When we consider the full financial picture at Chesapeake, including its high debt levels, its use of financial engineering, the relatively low quality of its financial data, the questionable nature of some of the CEO’s transactions with the company, and the apparent unwillingness of the board to put a stop to at least some of these practices, we believe the best thing for investors would be to replace the board and/or the CEO,” the note said.
In a follow up to Reuters’ initial story, Brian Grow and Anna Driver, reportedly uncovered an additional potential conflict of interest between McClendon and the company he helped create. The CEO sold his share of two significant energy plays at the same time Chesapeake divested its interest.
“I can imagine a scenario where Aubrey is suffering some financial distress and might want to get a deal done – and it’s not the best price for the company,” Joseph D. Allman, oil and gas industry analyst at JPMorgan in New York, was quoted as saying in the Reuters story.
More than one lawsuit has been brought against McClendon on behalf of disenfranchised investors, as a result of this news.