Thursday, January 24, 2013

You Put Your Peanut Butter In My Chocolate!

In Brief: Chesapeake-Methanex Gas Supply Deal Portends More To Come

Today Chesapeake Energy (CHK) and Methanex (MEOH) announced a long term gas supply deal:  The terms of the deal are that over a period of 10 years CHK will supply enough natural gas to a MEOH plant in Louisiana to produce 1 million tons of methanol annually.  It takes approximately 22 MCF of natural gas to make 1 ton of methanol ( - 100 CF makes 1 gallon of methanol and there are 333 gallons of methanol in a ton), so this deal equates to about 33 BCF a year.  As CHK has forecast 2013 production of 1,030 to 1,070 BCF of natural gas, this deal accounts for about 3% of 2013 natural gas production.  While that may not seem like much, this deal also has a very attractive form of upside for CHK in that the price it will receive for its gas will be partially based upon the market price for methanol.  Since methanol is priced at the margin based on its energy content as a substitute for oil and refined products, CHK is effectively capturing some of the price premium oil commands above natural gas of equivalent energy content.  Financial details have not been released (and they are unlikely to ever become public), but if this allows CHK to sell natural gas at a 1/15th or 1/20th multiple of the price of oil instead of the current 1/27th multiple ($3.50 natural gas/$95 oil) the company gains substantial upside to the current depressed level of natural gas prices.  MEOH benefits from this agreement because its feedstock costs for methanol are based on the price it receives for the finished product and so has a substantial amount of protection for its margins even if methanol prices move a long way up or down from their present level (methanol prices are volatile).

This appears to be a win-win deal for both companies.  Given the current glut of natural gas in the US, I expect to see more deals structured between gas producers and large end-users that improve the long term economics of both parties' businesses.  An additional benefit for the natural gas producers is that if enough of these deals are consummated (especially for new natural gas-using plant capacity), the excess supply depressing natural gas prices at present should gradually decline to yield a tighter market with more attractive spot prices for gas.  If this model is attractive enough, it could even be an indication that we might see a major end user (chemical company, utility, etc.) buy a natural gas producer.

As always, the above is not intended as investment advice.  Consult your advisors, do your own due diligence, and be careful.  You can lose money on this stuff.

Disclosure: I have long equity positions in CHK and MEOH and I am long calls on CHK.

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