The risks of owning natural-gas stocks in your portfolio flared with the recent news that Chesapeake Energy's chairman had taken out more than $1 billion in undisclosed loans using company wells as his collateral.
Natural gas has proved a frustrating conundrum for investors. For years, the prices of natural gas and crude oil traded together — both up and down. But that tandem relationship broke down in late 2008. Oil prices skyrocketed to more than $100 a barrel, but natural gas plummeted roughly 45 percent just this year, to $2 per MBtu (1,000 Btus).
For investors in natural-gas shares, this has been a painful, unexpected decoupling. So when Chesapeake Energy Chief Aubrey McClendon disclosed that he had made a side deal, it made the burn even worse.
Chesapeake Energy is the second-largest natural-gas exploration and production company in North America, behind only Exxon Mobil, and it has interests in local natural-gas resources, including the Marcellus Shale in the northern Appalachian Basin of Pennsylvania and West Virginia.
Many local fund managers in Pennsylvania, New Jersey, and Delaware have at some point purchased the stock for their portfolios, including Vanguard, Susquehanna, and the New Jersey Division of Investment. But is it time to sell Chesapeake? Or is it a better time to buy Chesapeake stock, now that it has fallen 45 percent this year, closing just over $17 Friday. Monday's close was $18, up about 3 percent.
Probably, it will be a buying opportunity once the company gets a new chief and a new board — the current board is stocked with members paid about $150,000 each in 2010 (not including stock awards) who enabled McClendon to handpick which wells he invested in (with borrowed money) while letting shareholders bear the full cost of the company's 45,000 or so other wells.
Phil Weiss, an oil analyst at Argus Research who has had a "sell" rating on Chesapeake, said in a note to clients Friday that it was in the best interest for McClendon, the board of directors, or both, to step down.
"When we consider the full financial picture at Chesapeake, including its high debt levels, its use of financial engineering, the relatively low quality of its financial data, the questionable nature of some of the CEO's transactions with the company ... we believe the best thing for investors would be to replace the board and/or the CEO," Weiss wrote.
For investors, individual natural-gas energy companies can be wildcat risky. Chesapeake Energy stock has moved in the same direction as natural-gas prices, which is part of the reason why its stock price and other natural-gas companies have suffered.
There is always the possibility that Chesapeake Energy's stock will drop so low that it could become a buyout target for a competitor or an activist shareholder such as billionaire Carl Icahn, who could engineer a brokered purchase as he did with El Paso Corp., which was purchased by Kinder Morgan. Icahn has been a shareholder in Chesapeake for at least a year.
Still, it's less risky to buy an energy exchange-traded fund than a single stock.
"The Chesapeake news … confirms why as portfolio managers we believe that using ETFs helps us to diversify away specific stock risk," said Dan Weiskopf, comanager at Forefront Capital, which manages client money using only ETFs. "I recognize that ETFs do not completely immunize investors from such issues. … But exposure to this name is managed at about 3 percent in the context of specific gas-driller ETFs, which investors may use if they want specific exposure to gas drillers."
There are 112 ETFs with Chesapeake as a component stock, worth about 3.5 percent of the free float, or the shares available to trade for the public.
For those who believe natural gas has gone so low it can only go up, there are "bullish" funds such as Direxion Daily Natural Gas Related Bull 3X (symbol: GASL) and First Trust ISE-Revere Natural Gas Index Fund (FCG).
For the bearish folks out there, check out Horizons BetaPro NYMEX Natural Gas Bear Plus ETF (HBNNF).
CHESAPEAKE'S LOCAL SHAREHOLDERS
The top 10 institutional investors in Chesapeake Energy in the Philadelphia region: