Why Going "Naked To The Strip" Means More Pain For Nat Gas Companies

Tyler Durden's picture

By Martin Katusa of Casey Research

Which Stocks Will Lose the Most in the Coming Energy Bloodbath

Yesterday, I made a prediction that should scare a lot of investors.

I predicted a massive loss in market valuation for some of North America's largest energy producers. You might own some of these names yourself.

I'll share some specific names with you in a moment... But before we cover them, it's important you know the dynamics that will drive them lower.

I covered the first dynamic yesterday. It's called "reserve write-downs." 

As you probably know, the price of natural gas has collapsed more than 60% over the past 12 months. Energy firms that carry billions of dollars of reserves on their books based on the "old" prices (around $4 per MMBtu) will have to "write-down" the value of those reserves to reflect the new prices (below $2 per MMBtu).

Natural gas reserves that were "economically recoverable" – and thus, extremely valuable – when natural gas traded for more than $4 per MMBtu back in 2010 are going to be worth much, much less... now that natural gas is below $2 per MMBtu.

The second dynamic involves "hedging." 

Hedging is when one party agrees to sell a commodity to another party at a particular price in the future. This strategy helps commodity producers and consumers know in advance what their price of a given commodity will be. It gives both parties a greater ability to plan for the future.

For example, a farmer might agree to sell his corn for $6 per bushel before he even harvests it. Or an oil producer might agree to sell his production for $100 per barrel. This gives the farmer and the oilman the certainty they need to run their budgets. Even if the prices of their given commodities fall, both the farmer and the oilman are protected from price declines. They've "hedged" their production.

Hedged natural gas contracts have protected many producers from the full wrath of today's rock-bottom prices. They've been able to sell their production at relatively high prices... even while the spot price collapsed.

But... for a lot of producers, these higher-priced hedges are about to expire.

Encana, Canada's largest natural gas company, is a good example. The company had prudently hedged lots of the gas it sold over the last six months. This means it was still realizing $4 or $5 per MMBtu on its sales. Now, those hedges are expiring... and the new hedges are at much lower prices. Encana's cash flow and its economically recoverable reserves are going to plunge.

Encana isn't the only natural gas company in this situation.

In recent months, the second-largest natural gas producer in the U.S., Chesapeake Energy, removed most of its gas hedges for 2012 and 2013 based on the belief that prices are at or near a bottom.

Such a move, known as going "naked to the strip," marks a major turnaround for a company that was one of the best and most active hedgers in the sector. Now, Chesapeake has no protection if gas prices continue to slide. It's a risky scenario seeing as prices are currently below production costs in most U.S. gas basins.

For investors, the fact that many North American gas producers are seeing their high-priced hedges expire makes it more important than ever to understand a company's cash flow picture going forward.

An investor must ask the following questions...

  • What percentage of production remains hedged and at what price?
  • How much will a company have to sell at or near the spot price?
  • What is the company's average cost of production?
  • Is the loss of high hedges about to send the company into the red?

These are the questions you need to ask... But be warned: you won't find very many producers with pretty short- and medium-term cash flow pictures.I expect natural gas prices to remain between $1.50 and $2 per MMBtu for the next 12 months.

Those prices will render a lot of production uneconomic. They will force companies to massively write down the value of their reserves. Cash flows will plummet. Shares in gas producers, while down a lot over the past year, will fall more than 25%.

The bloodbath in natural gas stocks is about to get worse.

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ihedgemyhedges's picture

If you had inserted the word "landing" before the word "strip", you would've piqued a lot more interest.................

Oh regional Indian's picture

I suppose the nationalization of the energy complex/grid is one of the top-most priorities of controllers, ne? Stands to reason.

You can ration something only when your hand's on the tap and the source.

I predict a wave of bail-ins for the energy complex and then....before you know it, not slight, just handy.. Gub owns the network, which may or may notwork, depending.



French Frog's picture

Just a thought: is NG's fall from the 2008 high due to simple supply & demand or ... is the Oil Cartel around the world simply defending its life by shorting NG to make sure that oil remains the 'top dog' !?

---> short NG (with all the profit/money made from high Crude/Brent prices) ---> NG price goes down ---> extracting NG becomes not viable ---> NG companies go bust ---> less NG gets extracted ---> price goes up again to a level that makes it uncompetitive with Crude ---> the Oil Cartel wins again.

Surely not ?

Pinto Currency's picture


There has been a surplus of nat gas produced from shale and conventional field and there was less nat gas used this past warm winter.

Replacement wells aren't being drilled and current wells are being shut-in because of low prices (Chesapeake) thus starting to limit supply.

Gas inventories are starting to narrow and the market will find its new economic equilibrium price point given additional shale gas feed but likely after some substantial whipsawing.



Until substantial new demand comes on-stream it will likely continue to trade at a substantial btu discount vs. oil but ultimately seeking a price above $2.50 per tcf to sustain production.


lolmao500's picture

What if... I know this is crazy... converted lots of cars to natural gas?? If Iran, a third world country is able to do it, why not the west? Oh yes, the western governments are owned by big oil...

Flakmeister's picture

Take off your metal collander hat or at least loosen the straps...

Try the following, ramp up an assumed 0.1% NG use for vehicles by 100% p.a., compute the corresponding displacement of oil taking into account a 23 year  proven reserve of NG (yes, that takes into account the shales)

Sounds like a Soviet Five Year plan....

That being said, the Repubs are thralls to the Big Oil and in particular the Kochs.... Hell T. Boone called out the Kochs for what they are recently



Caviar Emptor's picture

Yup. And none of the "projections" ever address the huge infrastructure costs to safely and effectively process, distribute, store and retail NG. Buildout would be costly and lengthy. Automakers would take advantage of the change to gauge on price of new "gas-o-matic cars". Better be sure you'll have enough to make it to the next NG filing station. Want to see what happens in a rear end collision

Bicycle Repairman's picture

There's a natural gas filling station near you.  And this is the 12th time I've told you guys this.


I have a natural gas "fill pipe" in my home already.  Anyone with natural gas heat has one.

Pinto Currency's picture


The Westport Innovations technology is going to be offered in F-150 and F-250 trucks this quarter and fleet truck and bus operators are starting to use the technology.

With this home filling device you can fill your auto in your home for less than $2.00 per gasoline gallon equivalent:


Cummins-Westport shipped 1,943 truck and bus engines this past quarter - the demand is building from fleet bus and transport truck operators who see substantial price benefit from fuel savings.  Retail will follow with a sustained stable price differential.



azlibertarian's picture

And how much would an interested buyer pay for this home filling device--the required infrastructure--in order to be able to access this $2.00gge home-filled CNG? I understand they're $6k or so (and I'm willing to be wrong here), but when you factor that cost into a cost/benefit decision, over the lifespan of a CNG vehicle, these benefits aren't quite so compelling.

Pinto Currency's picture


Yes, it depends how much you drive.

Nat gas costs about $1.50 per gasoline gallon equivalent from a home filling station so it depends how many gallons you use saving $2.00 to $2.50 each gallon.

Maybe split one with a neighbor.

It sure would work for industrial fleet vehicles that put on a lot of miles.

You could always stick with a retail nat gas filling station at about $2.50 per gasoline gallon equivalent.

azlibertarian's picture

Perhaps $6k does sound high, but I have a little, although distant experience here. I own a bi-fuel (gas and CNG) truck that I bought back in '99 under a program that Arizona was offering at the time. I didn't buy a home-fill unit then, but they had plans for these home fuel stations as part of the incentives to get motorists into alternative fuels. My $6k figure comes from my memory of what they were asking then (and again, I could be wrong on that).

But the math stays the same.

Let's make these assumptions:

  • The system costs $4k (not $6k, as per my memory)
  • I drive 10,000 miles per year
  • My mileage is 20 mpg.
  • Gasoline is $4/gal.

So, at 20mpg, I buy 500 gallons of gas a year. With gas at $4/gallon, I spend $2000/year on gas.

If I can pump CNG from my home fill unit at $2/gge, then I am saving $1000/year on fuel.

So, it will take me 4 years until I've recouped the cost of this home-fill unit.

Obviously, a higher price of the home-fill unit will move that break-even point further out, and your mileage will affect the math too (I get virtually the same mileage on CNG as I do on gas). If you have more than one vehicle using this one home-fill unit, then you'd break even earlier.

But the point is: the cost of the system has to be included in the decision on whether it is worthwhile to get into an alternative fuel.

Pinto Currency's picture


Or  you fill nat gas from a local nat gas station at $2.00 - $2.50 per gasoline equivalent gallon.

Consider also the price divergence of nat gas and oil prices due to the surge in gas production from shale gas - that spread will increase as oil continues its climb.

MarcusLCrassus's picture

But what kind of performance issues to NG cars have?  Reduced hp and torque = shit performance = less buyin from the public.  Count in the costs of conversion as well as maintenance infrastructure and NG powered cars have a real hurdle to climb. 

flyingpigg's picture

It makes more sense to apply NG for busses instead of cars. They have the tanks on the roof. Refilling at the overnight bus station. Many cities in Europe already have NG busses. Better air quality as well (compared to the usual diesel busses).

Bicycle Repairman's picture

Lets just offer the NG car.  People will buy it.  As for 23 yeaqrs worth of reserves, how many years of reserves did we know of 10 years ago?  And even if it is 23 years, you can mail that to 2035 when we'll care.

lolmao500's picture

A few years? If they wanted, they could roll out these next year just start the propaganda now...

Flakmeister's picture

NG will work for short range commercial fleets and for a few people with unusual circumstances.... As a general transportation fuel... fuggedaboutit...

Bicycle Repairman's picture

Natural gas will work for any automobile and there are kits to convert gasoline burning cars.  Honda makes an NG car.  Good luck getting one in the land of mandatory gasoline cars.

Gully Foyle's picture

Bicycle Repairman


Ford Super Duty Trucks to Offer Natural Gas Fuel Option

01:04PM Oct 03, 2011

According to AAA, the price of gas remains about 71 cents higher than at this time last year, which hurts anyone who drives a fuel-thirsty pickup truck for work or play. Fortunately for potential truck buyers, Ford recently announced that 2012 Ford Super Duty pickup trucks will offer a $315 setup kit to convert the base engine to run on compressed natural gas, rather than gasoline.

The F-Series Super Duty trucks already come standard with a 6.2-liter V8 engine that can burn either standard gas or E85 ethanol fuel. However, engines run far less efficiently on ethanol, which raises the annual cost of fuel. For instance, the EPA estimates that owners of a 2011 Chevrolet Suburban with four-wheel drive will spend about $3,100 on gas annually, while they would spend about $3,800 on ethanol annually.

Ford’s addition of a natural gas fuel option is good for shoppers because it will also save them money over diesel fuel. “Natural gas typically costs up to 50 percent less than diesel fuel on a per-gallon basis,” reports Automotive News.

A compressed natural gas conversion kit option is already offered on the Ford E-series and Transit Connect vans, even on models with a four-cylinder engine. Though the conversion setup is included in the $315 package, non-fleet buyers will have to purchase a separate compressed natural gas system and have it installed themselves. Shoppers can find kits for about $1,200 on eBay, and can buy natural gas at some gas stations.

Herkimer Jerkimer's picture

I watched these MF'ers run around Canada in the early 00's and scare the bajezus out of everyone, getting them to sign up into long-term contracts with NG for their homes.


It was all a setup. The big gas companies knew these lower prices were coming with fraking technology. Somebody should investigate for the collusion.


Anyway, I thought I'd like to get a big NG tank for my home, as I'd like to have a supply that I can purchase to control the cost. And get it refilled, in July, not January, like they like to do... The NG suppliers tell me that that won't happen because you can't compress NG like Propane. Ha-ha! You're screwed Herk!


How come I can now get NG for my vehicle? What happened with the No Compressy Gasy Excuse? What am I doing? Driving around with a big hose attached to my car?


I think it's probably got something to do with the same idea that I can't buy a 300 gallon drum of gasoline without jumping through hoops of fire with vats of hot bullshit underneath, so I can't buy gas when it drops to 60¢ a litre like 2009, as I'd like to have 2 1000 gallon tanks of NG at my house, at $1 rather than 5 dollars MMB.


Screwed again.



sun tzu's picture

Who is stopping you or anyone else from buying an NG car? Go to any Honda dealership and buy one or order it. They only cost 40% more than a regular Honda Civic.

Bicycle Repairman's picture

"They only cost 40% more than a regular Honda Civic."

That might be your answer there, except that there is no reason for the much higher price.

BTW, your avatar sucks.

Teamtc321's picture

It's just amazing how un-educated your comment is, diesel engines, our transportation fleet is switching now. Google clean energy and the picken's plan to start.

Any internal combustion engine, diesel or gas will run on nat gas. The engine will also produce way better fuel mileage thus dropping the price per gallon per se. 

Flakmeister's picture

It has to do with the infrastructure...

And you do realize that the US still imports NG on a net basis? Do you?

I predict a lot of people spending the money to convert and install the compressor getting burned when NG returns to historical pricing... They will never recoup their CAPEX (hence my comment above that NG will work for some but it is by no means a universal solution)


disabledvet's picture

Eh. Exxon Mobil will crush them far worse than any "failed hedge." change we no longer can believe in here we come!

Sudden Debt's picture

And this will create lower production which will cause higher prices and that 12 month timeframe will be worthless.
Try 3 months before commodities start to boom back up

Tyler Durden's picture

Indeed. However as gold has shown, there is a big difference in price dynamics between miners/extractors and the underlying commodity. As for capitalization considerations, see this.

Spitzer's picture

Gold is not a commodity that gets consumed. Gold has 70 years worth of stock to flow, most commodities have 70 days worth of stock to flow.

The reason gold is rising and the mining stocks are falling is simply because the western stock bugs dont believe in or understand gold while the rest of the world does understand gold.(India, China) And they are loading up on physical. They have no interest in mining stocks.

Its not like the general stock market is in a bear market. The DOW is close to 13,000 while mining stocks are close to 2008 lows.

Acorn10012's picture

I kinda thought that was TD's point...the commodity and company stock prices might not move in tandem.

Spitzer's picture

Gold is not a commodity. Bank stocks, house builders, home depot et al went up in tandem during the housing bubble

AUD's picture

The reason gold is rising and the mining stocks are falling is simply because the western stock bugs dont believe in or understand gold

Maybe but it's also because many 'gold miners' don't mine any gold. What they actually do is mine shares. They are just like these NG 'plays' that wildly overstate their reserves in a rising market, then the chumps who bought in at the top get fleeced.

Also, even some gold miners who do mine significant quantities of gold are so hocked that the only people making money off of the deal are the senior creditors. The company cannot pay a dividend so shareholders get nothing. A good example of this is Norton Goldfields, listed on the ASX.

Just another ponzi scheme.

Spitzer's picture

There is allot of shitty gold companies that would survive if there was one iota of interest in the sector from the general public.There is quality gold miners out there with ZERO debt and good assets. Goldcorp has no debt.

Look at all the companies that don't make any money who's stock price goes up and away. Linked-in for example. You make it sound like there is a ponzi problem in the gold sector but there is not enough money in the sector to support such bullshit.

AUD's picture

Dude, there IS a ponzi problem in the gold sector, I just described it. And at present, these ponzi schemes ARE being called bullshit on. That's why there is not "one iota" of interest in the gold sector, few of these companies can pay any dividend, they have nothing but empty promises. Many are having a tough time hanging on. Several 'gold miners' I bought shares in at more or less the bottom in 2008 are trading lower than 2008 & are 'restructuring' & so on, basically screwing existing shareholders. Some I bought shares in in 2008 have done ok, these seem to be the ones with better prospects.

My point is that the low share prices of these supposed gold miners is not just because westerners don't understand gold.

And I never said there aren't quality gold miners, nor that Linked-in is not a bullshit ponzi scheme.

Spitzer's picture

WTF are you talking about ?

What you are saying is that institutional investors and the general public are making wise and calculated analysis  of these gold miners and that is why the sector is starved of capital. That is total bullshit. They clearly don't believe in gold. All of the mining anylists for institutional investors currently price gold at $1200 when they are researching a company. That is proof that they don't believe in the gold bull market.

All you have to do is see what the institutional investors and the general public are buying into to realize that they are just delusional. Netflicks, Linked-in, Disgracebook, Groupon, the list goes on and on. If they are thinking rationally then why the hell are these same investors piling intp all this crap that has never made any money ?

They don't believe in or understand gold. That is the reason why the sector is starved of capital. As if they all of a sudden grow a brain and make wise analysis of gold miners. A shitty gold company has allot better chance of making money then a shitty pie in the sky social media company that has no assets, no cashflow or no nothing.

How many tech or social media companies pay a dividend ?

A gold exporer that has an asset they are working on, that doesn't have cashflow, does not make it a ponzi scheme. Yet this same company could go broke because the sentiment in the industry is so bad that no money comes in to capitalize it.

lizzy36's picture


Production y/y in natural gas is higher for every month in 2012 vs.2011 and 2011 was higher vs 2010.

There HAS BEEN no slow down in nat gas production in the USA. All these companies are chasing liquids and by product is dry gas. Also when one has already expanded the capital to drill a well, shutting it in is usually only done when storage is full. 

Current storage versus the 5 year average is 61% higher in the US and 70% higher in Canada. Switching (coal to nat gas) is helping but not enough.

In three months absent a hurricane price will bottom (end of August/September) and i expect go lower than the $1.90MCF we saw 3 weeks ago.

Also as soon as natual gas hits between $3 and $4 every producer will start flooding the market with product.

Reserve valutions are generally done on a yearly basis (usually late spring early summer). Writedowns are very material and affect a companies access to thing like credit lines. There can also be convenants in current debt instruments that are affected by material reserve writedowns.

US producers still have accessto  HY markets (thank ZIRP for that) but expensive capital is a short term solution and should include a prayer for higher commodity prices.

There are producers that will go bankrupt in this enviroment, and it will color the whole sector.


Flakmeister's picture

You are aware that the annual decline rate of current NG production without any new drilling is the equivalent to the production for the state of Texas?

Only exponential growth in the number of wells has led to relatively modest increases in production. And the US is still a net importer!

I predict ~$7 NG within 30 months.....

wrs1's picture

More like 18 months.  Go look at the charts of NG and see how fast NG bounced off these same prices.  On a nominal dollar basis, this price is far lower than when it was at $2 in 2002.  To me, that says it will probably bounce faster and higher than most expect because of just how far the pendulum swung. 

Flakmeister's picture

You may very well be right.... I think you are giving a lower limit and mine is more of an upper...

Omen IV's picture

there was no "winter" in the east and midwest US this year - no comsumption - if it happens again next year then what?

wrs1's picture

There HAS BEEN no slow down in nat gas production in the USA. All these companies are chasing liquids and by product is dry gas. Also when one has already expanded the capital to drill a well, shutting it in is usually only done when storage is full. 

Current storage versus the 5 year average is 61% higher in the US and 70% higher in Canada. Switching (coal to nat gas) is helping but not enough.

Actually, the EIA numbers say different.  As of 5/4/2012 current storage was only 44.5% higher than the five year average.  That storage is getting eaten up fast.  In fact, there has been no rise at all in NG storage from the producing region in the last six weeks.  That is unprecedented.  I assure you, gas is being shut in here in Texas, I know that for a fact.

Caviar Emptor's picture

Actually, one huge problem the producers have is that they can't reduce production even when prices drop because of the clauses on their leases which mandate production. 

wrs1's picture

Gee, you ever signed or negotiated a OGML with a producer?  Here in Texas they have this standard POS called the producer88 lease and it provides them an out with the shut-in royalty which they will never remove.  You can get them to make it higher but they won't take it out. Negotiating OGML leases that don't take you the minerals owner to the cleaners is tough work and slow to boot.

Caviar Emptor's picture

@wrs1 No, can't say I have your granular knowledge. But here is another take: 

Supply does not drop very quickly, even if prices fall, because producers need to continue to extract natural gas in order to repay loans and to comply with use-it-or-lose-it lease terms.


wrs1's picture

This is a myth that you are being fed by Wall Street.  Most producers already got trapped by bankers the last time around and they have protected their operations against this kind of price decline.  The only thing that chews up profits is failed exploration.  So what happens when producers quit drilling for new gas is that they quickly become cash flow positive and they can afford to shut some production in.  In fact, the stuff that is costing more to produce than it gets in the market is shut off very rapidly and the lease holders are paid shut in royalties.  At one time there were Take or Pay clauses but those were negotiated between producer and consumer, not producer and lessor afaik.  Lessors are generally in the weaker position vis-a-vis producers since they don't have the capital or expertise needed to exploit their minerals and that includes state lands here in Texas.

I am just giving you the view from someone who owns some land and gets paid royalties from actively producing wells, some drilled just in the last two years and others drilled decades ago, i.e. 80s and 50s.  We have been selling leases for years, lot's of times it's free money but once it goes HBP, they do what it takes to keep it HBP and shut in royalties are part of that cost.

RoadKill's picture

Sorry Tylor. I completely disagree with you. Nat Gas has bottomed and this is one of the best times to buy. Im not saying gas is going back to $8 anytime soon, but we have already gone from $1.90 to $2.50 and I see high 3s to low 4s as easily achievable in 18 months. UPL has gone from $100 to $20. This is not the time to push the short. Buy low sell high.

Acorn10012's picture

Watching nat gas for awhile...would like to see a higher low before I tip-toe in. Looking for supply/inventory to dry up a bit to help the situation. The dynamic TD mentions above might be one catalyst to reduce supply.