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Analyze CHK hedging strategy: I

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Chesepeake Energy logo

Chesapeake Energy (NYSE: CHK) is a stock I have known for a while. I traded it in year 2006, I did not hold it for long term partly because I usually don’t hold a stock for more than a year (until Mindray), more importantly I did not understand all the natural gas price volatility, CHK’s hedging strategy etc. Fast forward two years, the natural gas and CHK stock have been doing very well until last week, and I have studied the CFA a bit.

Chesepeake is a natural gas (plus a bit oil) explorer and producer, it’s No. 2 US natural gas according to its investor presentation (click its July 16 presentation here). Natural gas is nothing new, it’s mainly being used in power generation, industrial and residential (heat) use. Exploring and producing natural gas is not a sexy thing either, except CHK claims it has the best geo-scientists and engineering team in the industry. The ultimate differentiator of CHK, compared to its peers, is its large hedging strategy. Using hedging, basically it tries to get a predetermined fair price of its product (natural gas), or in other words, it tries to get a fair profit from exploring and producing the natural gas. It lays out its hedging positions in its quarterly report, and it regularly put updates.

How about its hedging results? Here are some articles I saw from seekingalpha.

Article one, article two.

Why hedging?

Simply put, CHK is like a corn farmer, a good corn havest does not necessarily translated into nice profit. Because the corn price could be very low if all the other farmers got good harvest, and if there is not as much demand. Same thing goes to CHK, a good exploring and producing year does not necessarily means nice profit, because the price of natural gas can be very low. By hedging the gas to be produced, CHK is saying we are not expecting making a windfall profit, but we are going to make a decent/fair profit.

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