Friday, July 31, 2009

Production Cuts and that OPEC Discipline

I was reading an article today regarding Chesapeake's earnings report that got me thinking (WSJ link should be good for seven days). One of Chesapeake's comments that has been picked up in the media is that the company is rescinding much of the production cuts it previously announced. They haven't been joined by competitors making across the board cuts (although many competitors are selectively choking back wells). It's sort of a "hrrrmpf, if nobody follows me, screw them" approach.

It got me thinking about OPEC, the international oil and gas cartel. OPEC members are notoriously bad about following production cuts called for by its leadership aimed at boosting or stabilizing prices. Perhaps I had too many iced teas at lunch, but I couldn't help think that Chesapeake saw itself as the self-proclaimed King of All Natural Gas and leader of an informal North American gas cartel. I guess things worked out the same for them as it usually does for OPEC leadership.

But public companies in the U.S. are not OPEC nations. We have strict disclosure rules whereby a company can't announce one thing and do something else without public disclosure. But there is a macro problem growing in the U.S as supply venues are filling up. At the same time, producers are drilling expensive wells and they need to get some short-term cash flow to support their operations. Just because Chesapeake can go without for a while doesn't mean a smaller competitor can too.

It's going to be interesting to watch the dynamics during the numerous earning announcements next week to see who is choking back and who is free-flowing, especially since the stock market seems to be responding positively to companies that announce production increases. Investing Rule #1: Never Assume the Market is Always Right. But maybe the collective wisdom of "if you build it they will come" might work out in the near term.

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