Just Don’t Blame the Decline in Chesapeake on Oil

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The price of oil has sharply declined in recent weeks and by extension United States Oil (USO) has also tumbled down in recent weeks. In addition there is an ongoing decline in the stock price of Chesapeake Energy Corporation (CHK); this company has appeared many times during the past few weeks in the news. There are calls against the company's leadership. There is a certain debate over the reasons for the recent fall in the company's stock and whether the decline in oil prices could partly explain the stock's performance. I will examine the relation of the oil with the stock's price and see by how much the recent decline in oil price could have affected the stock of Chesapeake Energy Corporation (CHK).  

Chesapeake has been on the news a lot lately over the downgrade in the company's rating after the company had taken a sizable short term loan of $4 billion at an annual rate of 8.5%. There are many other events and managerial decisions that are likely to be responsible for the decline in the stock’s price in recent weeks.

During the passing weeks there is also a downward trend in the prices of crude oil. There are many reasons that could partly explain the onward decline in oil prices including: the steady rise in OPEC’s oil production despite the boycott of Iran by Europe and the U.S;  the increase in OECD’s inventories levels; the ongoing debt crisis in Europe; many other considerations could have played a role in the decline in oil prices and by extension United States Oil (USO). I also suspect oil prices will continue to decrease in the weeks to follow. Could this mean that the fall in oil prices have had an effect on the stock price of Chesapeake?  

The chart below shows the development of the Chesapeake stock and oil price (C12 future) during the year so far.

 

<img src="/media/images/user_12845/oil-and-chk-2012-may_large.jpg" />

As seen in the chart, both prices are correlated. Furthermore, between 2011 and 2012 the linear correlation between the daily percent changes of WTI oil (C12 future) and Chesapeake stock price was 0.4, which is a strong and robust relation. This means the volatility of oil prices might explain at best nearly 16% of Chesapeake‘s stock volatility. But during 2012 alone, the linear correlation was only 0.26, which means oil prices could explain at best less than 7% of Chesapeake‘s stock volatility. 

 Alternatively (under certain assumptions) this means nearly 93% of the volatility of the Chesapeake's stock is coming from other considerations than the recent oil price tumble (some of which I have listed above).  

According to Chesapeake’s financial statement (2011) the share of oil’s revenues out of the total natural gas and oil related revenues were nearly 47%. Furthermore, the revenue of Chesapeake from Nat Gas and oil account for only 50% of the company's revenues; therefore the share of oil out of the total revenues is only a quarter, which seems to coincide with the linear correlation between the stock and oil prices.

Keeping in mind that natural gas prices have made a comeback in recent weeks; this rally could have eliminated some of the effect of the recent decline in oil prices that may have adversely affected Chesapeake's stock.

Assuming a linear relation between oil and the stock price, this could mean (assuming all things equal) that if oil prices were to decline by another $5 and reach the mid 80s, the stock of Chesapeake could decline by as much as $0.6 to $0.7 (I won’t belabor you with the details, and just point out I have done it by calculating the beta of the CHK against oil (percent changes) and translating the difference to changes in dollar). 

Therefore the recent decline in oil prices has had little to do with the tumble down in Chesapeake's stock price and even if oil prices will continue to decline it won't account for much of the fall of the Chesapeake's stock price.

This article on Chesapeake and Oil was first published

For further Reading:  Why the Recent Rally in Natural Gas won’t help XOM


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