Thursday, September 16, 2010

Trader Chesapeake

Not to pick on Chesapeake today, but one of the things that jumps out about the company's recent strategy is its reliance on trading fees to drive short-term profits and lock in long-term prices.  Kudos to management for aggressively positioning the company for good pricing in a low price environment, but the company's recent strategy has been to make money at hedging, not just manage its risk.  This is an unusual approach for an operating company.  No doubt that Chesapeake is stacked with smart traders to rival any Wall Street firm, but the trading aspect adds a layer of risk to the company because you ultimately get a little too smart for your britches.

Lately, the company has aggressively sold long-dated (2013 to 2020) call options on natural gas at $8.  Selling long calls on a product you produce is not necessarily risky, but it is an indication you don't expect prices to rise that high.  It also means that Chesapeake  has capped its price for a portion of its production at $8 for the next ten years.  But the trading activity has also generated a pile of cash that should be viewed as one-time money to boost short-term profitability.  The $8 ceiling for a portion of its production is not very optimistic, but it might be realistic.

Ultimately I wonder how involved an E&P company should get in speculative trading outside of operational hedging.  True, Chesapeake has the production to back up the options it is selling, but the company shouldn't lose focus or misdirect investors with one-time, short-term gains.  Is this the beginning of more risky trading activity?  Is there fire where there is smoke?  The company might be packed with brilliant minds that transcend the energy industry, but so was Enron.  (Harsh, yes, but the concern is valid.)

No comments: