Chesapeake Energy Corporation (CHK), Linn Energy LLC (LINE) – Contango 101: What It Means for Your Energy Investments

In fact, this is one of the issues Leon Cooperman recently pointed out when addressing those analysts and investors that are negative on Linn Energy LLC (NASDAQ:LINE). In a letter to the editor of Barron’s, Cooperman stated that the paper had written:

The capital Linn formerly committed to commodity options was spent “largely [on] in-the-money puts on natural gas.” This is wrong. Bary is conflating the spot price of gas with the forward curve, which has long been in contango [the futures are trading above the spot price]. He writes that “this has allowed the company to get more than $5…for its gas when the market price has been $4 or lower.” He is twisting facts to suggest that there is something untoward about hedging gas five years out at a premium to spot prices.

Contango can really affect a company’s ability to hedge its production, which is one reason why BP plc (ADR) (NYSE:BP) isn’t an active hedger, because the company has been burned in the past. Its belief is that investors own its stock in order to benefit from the rise in commodity prices, but the company is continually reappraising its strategy to hedge its natural gas exposure. While a market in contango can lock in solid earnings this year, a reversion to the mean will make it tough to keep the pace.

Hedging is an important tool for oil and gas companies. Some, like Linn Energy LLC (NASDAQ:LINE), are committed to hedging production for years in advance to lock in cash flow. Meanwhile, global giants like BP plc (ADR) (NYSE:BP) stay away from hedging because of the role contango can play in the market. As an investor, it’s important to know what your company’s stance is on hedging the commodities it produces because the market’s current condition can have a real effect on earnings.

The article Contango 101: What It Means for Your Energy Investments originally appeared on Fool.com and is written by Matt DiLallo.

Fool contributor Matt DiLallo owns shares of LINN Energy, LLC and has the following options: short October 01 2013 $25 puts on LINN Energy, LLC. The Motley Fool has the following options: long January 01 2014 $20 calls on Chesapeake Energy, long January 01 2014 $30 calls on Chesapeake Energy, and short January 01 2014 $15 puts on Chesapeake Energy.

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