Nobody seems to realize this, so I guess it should be mentioned. CHK basically hedge 100% of their future oil production until the end of 2015. This means that if everything were going well for this trust, it would not realize any benefit from the recent run up in oil prices. The hedges were around $88, so every quarter they must pay everything over $88 they make on oil sales to the counterparty. The problem is, currently, they are only producing about 80% of what they hedged. That means to make up the difference, they will have to use profits from NG and NGL sales. Both these markets have been depressed.
This month, CHK said they would slow down the drilling of new wells to come up with a plan B, since plan A for the field failed so badly. These wells have a steep decline rate, so with less wells coming online.....the trust production will drop even lower than what was planned, since they won't be replace the drop in production from older wells. Yet, the hedges remain, soon the trust will only be selling enough oil for probably 60% of the hedges. It should also be noted that as reservoir pressure is goes lower, the percentage of total production that is natural gas will increase as it falls out of solution in the ground. Though, I do agree that within the next 6 months, natural gas will probably come up in price......I would bet $5 is the highest it gets during the coldest part of winter, but will fall back next summer likely. It definitely won't pick up the slack for the lack of hedged oil production.
The best thing to do is to sit back, and wait for CHKR to find its new fair price. I would guess somewhere under $10. They get punished by higher oil prices, and will be producing more than expexted natural gas which sells at an extreme discount to what they originally expected. Hopefully they can stem the drop in oil production so they can cover the majority of the hedges. If not, the hedges do risk busting this trust!
A quick question?
"This month, CHK said they would slow down the drilling of new wells to come up with a plan B, since plan A for the field failed so badly."
Doesn't the agreement that CHKR have with CHK call for "X" amount of new wells in "X" amount of time?
I think I remember a report last year that said CHK was falling behind in new wells but would catch up?
Don't think CHK can just "rethink" this part?
That is true.....But they can drill all the wells in one year if they wanted to, or change the placement of those wells. CHK will maximize there potential from the trust. Delaying capital spending until the very end, and then just place a bunch of useless wells might fulfill that requirement? The plan B may not be in CHKR ultimate favor.....
You claim that CHKR basically hedges 100% of their future oil production until the end of 2015, but according to the prospectus, the hedge is 50%:
"On November 16, 2011, Chesapeake novated to the Trust, and the Trust became party to, derivative contracts covering approximately 50% of the expected oil and NGL production and approximately 37% of the expected revenue (based on NYMEX strip oil prices as of October 28, 2011) attributable to the Royalty Interests from October 1, 2011 through September 30, 2015."
I understand CHKR paying the difference over $88 for oil, but wouldn't production have to fall below 50% of expected volume before it would affect profits from NG production? It seems the company is paying out $1 million in derivative contrcts over the past few quarters.
Yes, they claimed to hedge 50% of the projected oil production and 50% of the projected NGL production. The problem is, the NGL production was hedged at 49.2% of the price of oil. They produce about double the amount of NGLs as oil. And since NGLs don't track oil anyways, they are also losing on the basis. Oil prices are going up, so they must pay the extra.....yet NGL prices fell, and so they never got extra money from selling the physical commodity to offset the hedge.
But even CHKR knows they basically hedge 100% of projected oil production, since there 10Qs and 10Ks don't break out the NGL hedge from the oil hedge, they just lump all the oil contracts together. You statement about oil production falling 50% from projected......I actually wouldn't be surprised if that happens next year. With the reduced rig count, they won't have as many new wells online at peak production......and those that do come online, will produce at lower rates than previous projected.