Wednesday, January 20, 2010

Chesapeake's Hedging Activity

I saw an interesting piece on seekingalpha.com about Chesapeake Energy's hedging activities.  I tend not to follow the hedging of gas producers too closely because it is largely irrelevant to the commodity value on which mineral owners are paid, but these activities do signal a company's belief about the trajectory of gas prices.  The article notes that Chesapeake has hedged 43% of its 2010 production at $7.49/Mcf (summary shown on slide below).  Several months ago, the company only had hedged 14% of its production, but at a price of $9.53 (likely based on trades made in 2008). 


Chesapeake's hedging activity is in stark contrast to a recent announcement from Devon Energy that it has hedged 42% of its 2010 production at $6.10.

While Chesapeake has been very vocal in its belief that gas prices will rise, it seems to have made a good business decision to lock down pricing on half of its production.  The company hedged 43% of 2010 production through swaps, which represent a specific price for the commodity, and 8% through collars, which gives you downside protection for a certain quantity of gas in exchange for some potential upside, thereby creating a pricing band, or collar.

While Chesapeake may be a believer in higher prices, the company is smart enough to lock in some pretty good projected prices.  Hedging commodity prices for producers is all about risk management, but figuring out when and how to formulate the trades is a difficult game with significant financial implications.

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