Company Summary

 

Louis Dreyfus Natural Gas Corp.(NYSE:LD) is one of the largest natural gas companies in the U.S., primarily involved in the production, exploration and marketing of natural gas and crude oil.  Louis Dreyfus’ primary “core regions” of activity include West Texas, New Mexico, mid-continent and the Gulf Coast.  Net income for fiscal year-end December 2000 was $98,260,000 on revenues of $477,285,000 and total assets came in at $1,501,965,000.  As of November 1, 2001, Louis Dreyfus Natural Gas was acquired by Dominion Resources (NYSE: D) for $2.3 billion in cash, stock and assumed debt.

 

Exposures

 

After a detailed revue of the firm’s recent annual report and Form 10-K, I’ve determined that Louis Dreyfus Natural Gas has no significant foreign currency exposure.  To compensate for the lack of foreign currency risk in the realm of this report, I’ve included two additional independent variables in my prediction and analysis: monthly average temperatures (southern region of U.S.) and a weather factor. Demand for both natural gas and electricity in the United States is largely driven by weather conditions.  Air conditioners in warm weather increase electricity demand and natural gas is used to heat homes in cooler weather.  Additionally, the electricity generated for warm weather cooling is often derived from burning natural gas. In the Business Strategy section of the Form 10-k, Louis Dreyfus states “natural gas continues to gain recognition as an efficient, clean and environmentally-friendly fuel source alternative.  This is particularly true for electricity generation facilities, which are increasingly turning to natural gas for their power consumption needs.”  Louis Dreyfus’ stock should be effected by changes in weather patterns.  Specifically, I would expect a more favorable effect on stock price when weather conditions are at or beyond seasonal expectations.  I would predict that a warmer than average summer or unusually cold winter would result in a favorable movement of Louis Dreyfus’ stock price. In order to measure any additional benefits due to extreme weather conditions, I’ve developed a “weather Factor” to include as an independent variable in addition to % change in temperature. 

 

Louis Dreyfus states on page 4 of the Form 10-k “about 89% of our reserve base is comprised of natural gas, making us substantially more leveraged to natural gas than the industry average.”  Louis Dreyfus has significant exposure to price changes of natural gas. Because of its large reserve base and activities in exploration and production, Louis Dreyfus would benefit from strong natural gas prices.

 

Louis Dreyfus maintains a $450 million revolving credit line with a variety of banks. As stated on page 28 of Form 10-k, “the applicable interest rate was LIBOR plus 23 basis points.”  The use of an index based interest rate demonstrates an exposure to floating interest rates.  Hedging activity aside, Louis Dreyfus’ stock should be adversely affected by an increase in floating interest rates.

 

Derivative-Based Hedging Activity

 

Considering the significant exposures to commodity and interest rates noted above, Louis Dreyfus is engaged in a variety of derivative-based hedging activities.  On page 31 of form 10-k, Louis Dreyfus addresses the company’s use of derivatives to hedge commodity price and interest rate exposure:

 

“Our results of operations and operating cash flows are impacted by changes in market prices for oil and gas and changes in market interest rates.  To mitigate a portion of this exposure to adverse market changes, we have entered into fixed-price contracts and interest rate swaps.  All of our fixed-price contracts and interest rate swaps have been entered into as hedges for oil and gas price risk and not for trading purposes.”

 

After reviewing the quantitative data given for the company’s hedging activity, it becomes obvious that a fair amount of risk remains unhedged.  Louis Dreyfus engages in long-term fixed price forward contracts, swaps and collars to hedge it’s risk associated with natural gas and oil prices.  However, it is stated on page 31 of Form 10-k that only 44%, 55%, and 50% of natural gas production was hedged for 2000, 1999, and 1998 respectively.  In the 2001 outlook discussion on page 30, Louis Dreyfus states that expected gas production ranges from 132 Bcf to 144 Bcf.   On page 31 it is noted that “as of December 31, 2000, fixed-price contracts are in place to hedge 82 Bcf of future gas production in 2001.  This represents only 57% of  2001 production being hedged.

 

Louis Dreyfus engages in interest rate swaps to hedge against it’s borrowing activities.  The firm uses fixed for float interest rate swaps to transfer a portion of it’s interest payments from floating to fixed.  An average of 5% is paid in exchange for three-month LIBOR for each period on a notional principle of $125,000,000.  As with the commodity price exposure, the interest rate hedge represents less than half the total interest rate exposure.  The principle value of outstanding debt as of December 31, 2000 was $605,153,000 (form 10-k, page 37).  Based on the ratio of interest rate swap notional principle to outstanding debt, I would predict that rising interest rates would adversely effect Louis Dreyfus’ stock price.

 

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