Will Natural Gas Fall to $2? – Chesapeake Energy Corporation (CHK)

The natural gas market continued to cool down as prices declined despite the cold weather. Will natural gas reach the low prices recorded at the first half of 2012? How will the prices of natural gas affect the major oil and gas producers such as Exxon Mobil Corporation (NYSE:XOM) and Chesapeake Energy Corporation (NYSE:CHK). Let’s explore these issues.

During January, the price of natural gas declined to a monthly average of $3.36/mmbtu, which is nearly 2.9% lower than the average price of natural gas during December 2012. Nonetheless, it is still well above the price of natural gas recorded during the same time in 2012. The current price is nearly $0.97/mmbtu than the price reached during January 2012.

The extraction season is in midterm and is likely to continue in the next seven to ten weeks depending on how cold will the weather be in the coming weeks.

The natural gas storage is still higher than the five year average by nearly 12%, but due to the rise in withdrawal in recent weeks the storage is lower by almost 7% than in the parallel time in 2012.  During January, the withdrawal from storage was 715 Bcf. In comparison, in January 2012 the withdrawal was 506 Bcf. Last year, however, was among the hottest winters on record. This was another contributing factor to the drop in natural gas prices during that year. The 2012/2013 winter doesn’t seem to be as hot as in 2011/2012. Therefore, the price of natural gas isn’t likely to plunge to the $2 mark as it did last year. On the other hand, the price isn’t likely to rally to the $4 mark, because this winter seems to be hotter than normal (for now). The extraction from storage in January 2011 was 744 Bcf and in 2010 it was 870 Bcf. If the amount of natural gas extracted from storage is an indication for the demand for natural gas, then the demand for natural gas this season is higher than in 2011/2012, but lower than in the preceding years.

The natural gas production continues to slowly rise at a slower pace than in 2011. One indication for the decline in natural gas production growth is the drop in number of rig counts, during last month the number of natural gas rigs fell by 11 to reach 428. In comparison, during the same time in 2012, the number of rig count was nearly 745. One of the reasons for the drop in rig count was the shift toward shale gas extraction. But the low prices, compared to the five year average, are also contributing to the shift from natural gas to oil rigs. During last month the number of oil rigs rose by 14 to reach 1,332 rigs. The current number of oil rigs is almost 7% higher than the same week last year.

Let’s examine how the drop in natural gas prices had affected leading oil and gas companies in the last quarter of 2012.

Chesapeake’s natural gas operations account for nearly half of its revenues. Despite the low price of natural gas the company’s production continued to rise: in the third quarter the company produced 381 Bcfe – a rise of 24% compared to the same quarter in 2011. I suspect this trend might change in the quarters to follow as the company may shift its business to rely more heavily on oil than natural gas.