In the always-volatile energy industry, companies are constantly looking for ways to minimize risk and ensure profitability.
Hedges, collars, long-term contracts and other financial mechanisms often are used to help companies more accurately plan for their costs and revenues.
Some companies take the effort a step further.
Oklahoma City-based LSB Industries Inc. this week announced that it is getting into the natural gas production business.
The chemicals manufacturer and marketer bought a 7.7 percent stake in 57 existing and planned Marcellus Shale wells in Pennsylvania for $49 million, plus an expected $38 million to $40 million to develop the wells that have not yet been drilled.
Tony Shelby, LSB's chief financial officer, doesn't consider the deal “an acquisition of business.”
“This is a form of a hedge. It's in lieu of doing a derivative on the NYMEX (New York Mercantile Exchange) market. It's a pretty perfect hedge in the way we've calculated the costs of producing wells,” he said.
The natural gas interests were purchased by LSB's chemicals subsidiary, which each year buys more than 12 billion cubic feet of natural gas for use in its fertilizer plants in Oklahoma and Alabama.
LSB's effort is in line with a similar strategy followed earlier this year when Delta Air Lines bought the 185,000 gallon-per-day Trainer Refinery near Philadelphia from Phillips 66 for $150 million.
Delta executives think the airline can refine its own jet fuel for a less expensive and more consistent price than purchasing it on the open market.
LSB bought its natural gas well interests from Oklahoma City-based Clearwater Enterprises Inc., which still retains about half of its previous investment in the Pennsylvania wells.
“It's a win-win for both us and LSB,” Clearwater President Tony Say said. “For Clearwater, it clears us of all our debt and left us with some really nice cash to invest in the Marcellus further.”
Natural gas prices plummeted in early 2012 as rapidly increased production combined with a warmer-than-average winter to flood the markets with available fuel.
Production has since dropped as the industry refocused on more expensive crude oil and natural gas liquids.
“Is gas going to be $10? I don't think so, but it could very well be over $5,” Say said. “That could change the economics of a fertilizer plant. To hedge against those numbers, forward-thinking companies like LSB are buying resources. I think you'll see more of that in the future.”
It's an interesting experiment.
And now seems the time to try it.
With low natural gas prices, the cost of investing in natural gas production is relatively low. If prices stay low, the newest venture will be less profitable, but LSB's chemical costs also will be low.
If, however, natural gas prices climb, the company's expenses will go up, but it will profit from its Pennsylvania natural gas wells.