Saturday, January 30, 2010

Are Hedge Funds and Financial Institutions Holding Natural Gas Producers Hostage

For public interest, senior energy executive and institutional investor Karl W. Miller, today issued the following statement through his advisors regarding the U.S. Natural Gas Industry.

CHK is a unique natural gas company, in that it is rated Outperform by a collection of 29 independent analysts, the number one (1) rated outperform natural gas company by retail investors, yet it is the most heavily shorted natural gas company by hedge funds and financial institutions.

Mr. Miller has previously opined that based on his over twenty years in the commodity industry and specifically energy, that natural gas futures and swaps prices are being artificially manipulated downward in the current market.

When you look at CHK as an example of why short sellers might be manipulating prices downward, some high profit reasons become clear. CHK is in essence a proxy for a natural gas futures contract, but with the asset protection of owning its natural gas production.

CHK utilizes volumetric production payments or what we used to call the gas bank, whereby they finance future production by borrowing against reserves in the ground and then delivering physical gas to the lender who in this case is the financial institutions. This is in addition to having major global partners like Total, BP, Statoil, and others in club arrangements for its production assets, which Mr. Miller has opined is a very good strategy. Major oil companies have a long history of partnering and risk sharing in natural gas and oil production fields (consortium's) globally.

Mr. Miller has also opined that CHK and other natural gas producers should not be hedging long term at the currently depressed natural gas prices. CHK has abided by that doctrine, believing that better prices are ahead, which Mr. Miller concurs. Therefore, if one takes CHK as a proxy for the entire natural gas producer community, one can easily see why the hedge funds and financial institutions would continue to manipulate natural gas futures contracts and over the counter swaps prices down, to profit substantially if natural gas producers hedge with them to lock in prices, as well as to lock in artificially low volumetric production prices for financing purposes.

Keep in mind that financial institutions make a majority of their money from proprietary trading, not customer business. Customer business facilitates proprietary trading. Mr. Miller can say this from experience, as he used to trade proprietary capital for a major money center financial institution and has executed billions of dollars worth of structured energy transactions globally over his career.

If we take a closer look at CHK, they have one of the industry's best
collections of natural gas assets in the U.S. Chesapeake's future growth prospects are largely driven by its positions in what it refers to as the Big 4 shale plays - the Haynesville, Marcellus, Barnett and Fayetteville Shales. The company is less hedged than normal for 2010, as management believes there will be better opportunities to secure more favorable pricing than are currently available, consistent with Mr. Miller's views and recommendations for the entire natural gas sector.

Positive Factors on CHK Valuation (per MarketEdge Research):

The Price/Book Value ratio is 1.39. The average Price/ Book for this Industry
Group (Oil-Exp. & Prod.) is 13.71.

The Price/Cash Flow ratio is 20.14. A low ratio shows a strong ability to
generate cash and reflects well on a company’s stock price and liquidity. The
average Price/Cash Flow ratio for this Industry Group (Oil-Exp. & Prod.) is

The Price/TTM (Trailing Twelve Month) Sales ratio is 1.89. A stock with a low
Price/Sales ratio indicates a stock is not overvalued. The Price/Sales ratio is
significant since it is harder to manipulate sales than earnings. The Price/TTM
Sales ratio for this Industry Group (Oil-Exp. & Prod.) is 6.50.

The Operating Cash Flow was Positive in the last three years.
Growth Potential:

The prior quarter Earnings Per Share (EPS) growth rate of -94.90% is greater
than the TTM EPS growth rate of -436.15%.

Mr. Miller set an acquisition price of $35.00 per share based upon a mean analyst price target of $29.00/share in 2010. See link:

The Analyst community have raised their mean target price to $35.00 on a stand alone basis, without any acquisition premium, should a buyer emerge.

Analyst Consensus Forecast:
The EPS forecast for the next two quarters is greater than the prior quarter EPS.

FactSet Earnings Estimates
Analyst Rating OVERWEIGHT
Number of Ratings 29
Current Quarter $0.68
Next Quarter $0.59
Current Fiscal Year $-0.22
Next Fiscal Year $2.56
Surprise % N/A
Year Ago Earnings $3.55
Average Target Price $35.00

Mr. Miller's take away from this summary analysis is that the markets clearly believe CHK is the number one acquisition candidate and have been positioning the natural gas prices and shorting CHK down artificially to capitalize on i) a fundamental positive shift in Natural Gas Consumption; ii) an announced acquisition of CHK by a third party, which would enable short sellers to flip into long positions through purchasing out of the money options above the current stock price (which we have see substantial $30.00 calls purchased); and iii) an attempt to hold CHK (and other natural gas producers) hostage on hedge contract prices.

This column, Energy Commentary from Karl Miller, is the opinion of Karl Miller.
Investors should seek the advice of a qualified investment professional prior to making any investment decisions.

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