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Permalink Reply by Jules Clement on October 21, 2009 at 3:49

No, not missing anything. You got it!

But, it is not a 'Chesapeake thing'. Royalty owners get paid the spot price, while Chesapeake (and others) receive their agreed upon hedge price.

Simply put.

Jules

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Permalink Reply by Skip Peel - Mineral Consultant on October 21, 2009 at 3:51

Les. There are a number of past discussion threads that go into greater detail if you would care to review them. Jules is correct.

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Permalink Reply by Catfish on October 21, 2009 at 4:22

Another way to look at hedging,it enables the company to balance their profits. If they were getting spot pricing for the last year this play would be on hold untill pricing improved or they would be needing a goverment bailout. I could see O asking congress for billions of dollars to bail out the O&G industry.LOL

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Permalink Reply by Checkmateking on October 21, 2009 at 4:14

How would you feel if Chesapeak was hedged at 6 dollars and the price of gas went up to 9, would you still want the hedge price then, or would you prefer the spot price.

As to who benefits from hedging, whoever takes the correct position, but in Chesapeakes case a bird in hand is better thean two in the bush.

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Permalink Reply by Mac Davis on October 22, 2009 at 8:54

I wonder if any of the production/leasing companies do try to sneak hedged prices into royalty payments when the hedged price is less than the cash price?

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Permalink Reply by Grillin' - MmmMmm on October 22, 2009 at 10:23

It generally isn't that easy to do since the hedges are settled in completely different accounting. I'd be surprised, but others here are more wary of companies than I am!

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Permalink Reply by Grillin' - MmmMmm on October 21, 2009 at 6:38

Les: hedging is a financial transaction that in many cases isn't tied to particular wells, fields or molecules. So when CHK hedges a volume of gas, it doesn't say I'm hedging my gas from wells A, B and C. They contract the rights to sell a volume of gas at a certain price. This is usually traded in a market with lots of trade off's, etc. In many cases, they will also hedge basis differential. So, they buy gas at the pricing marker for a basin and sell it at the contracted price, hoping it will be higher.

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Permalink Reply by Les Bamburg on October 21, 2009 at 6:38

Just to add some clarification. The correct term is "cash price" rather than "spot price". The majority of natural gas in the US is sold on a monthly basis at a price established during bid week which occurs shortly before the month in question. Some natural gas is sold on a daily basis with the price being renegotiated each day.

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Permalink Reply by Mac Davis on October 22, 2009 at 8:51

Don't worry. You don't get the benefit of their hedging, but you don't pay the costs of their hedging, either.

(Unless they're committing fraud in your royalty payments, and charging you hedging costs, or paying you "negative" hedged prices.)

If you want to benefit from hedging, you can speculate on the natgas prices on your own without having the production company do it for you.

In theory, hedging does not pay off on a cash basis in the long run. They make money hedging if prices drop, and lose money hedging if prices go down. If it didn't balance out (or lose) in the long run, nobody would sell them the financial instruments that lets them hedge. The benefits of hedging are that they don't ride the roller coaster of high and low gas prices. The company doesn't go bankrupt when gas prices drop from $13 to $3. Depending on how the hedges are done, they either make a little less profit all the time buying options, or don't get the benefit of price spikes because they're sold futures.

Everyone assumes that companies that hedge always profit from their hedges. You only profit from hedging if you guess right on when to hedge and when not to hedge. If you're smart enough to always guess right on when and how to hedge, you wouldn't bother with your main business, you'd simply trade O&G futures and options and make your money that way.

I've always disliked companies that hedge. If I buy shares in Smith Oil company, I want to get full benefit from any peaks in oil price. If I want to be hedged, I'll buy my own oil price hedges, rather than letting Smith do it for me. An O&G company or customer that hedges is essentially speculating on the the commodities market with the stockholder's money.

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