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Oil and gas producer revenues can suffer if commodity prices drop

Ingrid Pan, CFA

Oil and gas prices directly affect upstream energy names (Part 1 of 5)

Revenues for upstream energy names are based on oil and gas production volumes and prices

Upstream energy companies (also referred to as “exploration and production” or “E&P” companies), such as Chesapeake Energy (CHK), produce hydrocarbons like crude oil, natural gas liquids, and natural gas. So the revenues for E&Ps are a direct function of how much oil and gas they produce as well as the prices of oil and gas. Commodity prices therefore affect upstream companies’ revenues and ultimately their earnings and stock price (valuation)—as well as ETFs that contain upstream companies, such as the Energy Select Sector SPDR (XLE), the SPDR S&P Oil & Gas Exploration & Production ETF (XOP), the Market Vectors Unconventional Oil & Gas ETF (FRAK), and the iShares US Oil & Gas Exploration & Production ETF (IEO).

Different price scenarios and energy company earnings

Some companies tell investors how sensitive they are to commodity prices. For instance, Chesapeake in its investor presentations (found on the company’s website, in the “Investors” section) gives its forecasted revenue and earnings under various natural gas price scenarios, as its production mostly comprises natural gas. Given WTI crude oil (the US benchmark crude) prices of $100 per barrel, and Henry Hub natural gas (the US benchmark for natural gas) prices of $3.00 per MMBtu (millions of British thermal units), CHK forecasts 2013 oil and gas revenues of $6,570 million. Given a move of $1.00 per MMBtu higher in natural gas, revenues are forecasted to total $7,020 million. With another $1.00-per-MMBtu move higher in natural gas, revenues are forecasted to total $7,470 million. So, for every $1.00-per-MMBtu move in natural gas, revenues fluctuate by ~$450 million.

Note that Chesapeake has stated that it has some hedges in place to protect against downward price movement. Many upstream energy companies enter into financial derivative agreements to reduce downside commodity price risk. These contracts might include locking in a certain price for production or receiving money if commodity prices fall below a certain level.

Taking a more in-depth look, you can examine the 2Q13 results for Chesapeake Energy (CHK), which we dicuss in the following section.

Continue to Part 2

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