In recent weeks two large natural gas consumers, Nucor and LSB Industries, have announced that they are purchasing natural gas "working interests" to hedge their natural gas price risk.

According to a press release as well as SEC filings, Nucor is building on a previous agreement it signed in 2010 with Encana, whereby Nucor will invest about $542 million over the next three fiscal years and approximately $3.64 billion over the estimated 13 to 22 year term of the agreement to purchase a 50% stake in numerous wells to be drilled and operated by Encana.

Commenting on the deal with Encana, Nucor's Chairman and CEO, Dan DiMicco stated, "We are always searching for ways to improve our competitive position and drive sustained value creation over cycles.  The increased exposure to natural gas prices that will accompany our current and potential DRI production, combined with the tremendous advances that have been made in the natural gas industry, have created a unique opportunity to leverage our strong balance sheet to create what we believe will be a lasting competitive advantage for Nucor.  This is a win-win proposition for both Nucor and Encana, and we look forward to a long and productive relationship." 

Similarly, LSB Industries recently announced that it is purchasing natural gas interests from Clearwater Enterprises. According to the press release, a subsidiary of LSB is purchasing a 7.7% working interest in various natural gas wells and leaseholds from Clearwater at a cost of $49 million.  In addition, LSB said it plans to spend an additional $38 to $40 million from the expected cash flows from the producing wells to fully develop their share of the leaseholds over the next three years.

According to Tony Shelby, LSB's chief financial officer, “This is a form of a hedge. It's in lieu of doing a derivative on the NYMEX market. It's a pretty perfect hedge in the way we've calculated the costs of producing wells.”

As we've previously mentioned, Delta Airlines announced last May that it was going to acquire the ConocoPhilllips refinery in Trainer, Pennsylvania in an attempt to lower its fuel costs. What's interesting about the Delta deal is that (at least based on our interpretation of the statements regarding the refinery) their didn't acquire the refinery in attempt to mitigate their exposure to fuel price volatility.  Rather, they purchased it in attempt to lower their net fuel cost by capturing the refining profit margin, also known as the "crack spread".  Which is quite puzzling given that the primary reason that many refineries are currently for sale is that the crack spreads simply aren't wide enough to produce a decent return on investment.

Which begs the question, are these deals outliers or are they the beginning of a larger trend whereby consumers will go "direct to the source" rather than hedging with forward contracts or financial derivatives?  Based on our discussions with numerous energy consumers, it's sounds as if there's a decent probability that we will a few more deals between natural gas producers and consumers as the economics, at least currently, have the potential to produce "win-win" situations.  That being said, we think it's safe to say that transactions of this sort will continue to remain the exception, rather than the norm.

On the other hand, we think it's highly unlikely that we will see any other large fuel consumers, such as airlines, bidding for refineries as operating a refinery entails significant operational, environmental and regulatory risk, not to mention the fact that refiners requires significant capital expenditures.  In addition, refiners wouldn't be selling their assets en masse if they were generating significant profits.

At the end of the day, the only certainty surrounding such deals is that the media will certainly be quick to declare the acquirers as brilliant or incompetent strategists.