Chesapeake Energy (NYSE:CHK) is the second-largest producer of natural gas in the U.S. At prices under $4 per 1000 cu ft, CHK is losing money on every puff of natural gas that it produces.
Right now the company produces about 4.1 billion cu ft of natural gas equivalent per day from about 22,000 net wells. The 22,000 wells represent about 20 years of drilling. On average, each well is producing about 186,000 cu ft per day. That's a lifetime production of about 1.5 billion cu ft of natural gas per well. These wells are probably not profitable to drill at NG prices under $8/Mcf.
CHK has cut back NG drilling by 90% and gone on a crash program to produce crude oil. Since an oil BTU sells today for about four times the price of a NG BTU, it is in CHK's best interest to spend its drilling budget on oil wells instead of NG wells.
So, how is it doing on producing oil?
During the 12 months from March of 2011, to March of 2012, CHK increased oil production by three million barrels. It only took the company six months to increase production by another three million barrels. The slope of the curve would seem to predict another three million barrel increase, or more, in the next three to four months.
During the most recent quarter the company produced a total of 9.236 million barrels of crude oil from a total of about 480 primarily oil wells or about 208 bbl of oil per day per well. These wells also produced about 93 bbl of NG liquids per day, for a total production of about 300bbl per well per day of liquids. These wells also produce enough associated NG to keep CHK's NG production growing even though they have cut NG drilling by 90%.
In six quarters, oil production has increased from 5% of total output to 14% of total output. Including NG liquids, total liquids have increased from 10% of output to 21%.
The interesting thing is that while liquids represent 21% of BTU output, liquids now represent 61% of CHK's revenue and is growing at an increasing rate. The newer wells are producing at a higher rate than those of six quarters ago.
The most recent earnings conference call indicated that the time to drill a typical shale oil well had dropped to 15.5 days. The company is running 80 rigs targeting oil. Each rig should be able to drill five wells in a quarter. That would be 400 wells, with an equivalent of 200 wells on production for the entire quarter . Each completed well should produce 200bbls of oil per day, or 40,000bbls total new oil per day. Over the 90 days of the quarter the numbers compute to 3.6 million bbls of new production for the quarter. the key here is completed wells. We can't know the number of wells waiting for fracking or take away pipelines.
All taken into consideration, the CHK conversion to liquids production, begun only a year and half ago, is well down the road to success.
A look at Chesapeake assets:
The most recent CHK investor presentation lists proved reserves at 21,265 trillion cubic feet of natural gas equivalent and a daily production rate of 4.14 billion cubic feet of natural gas equivalent. That is 14 years of production at current rates.
Previous investor presentations list a number for unproved resources at 348 trillion cubic feet of natural gas equivalent in addition to the proved reserves described above. At the current production rate, CHK has 230 years of resources in the ground.
If we were back in the 1950s, we would have to take the 348Tcf of unproved resources with a large grain of salt, but the seismic technology of 2012 is good enough to predict that the 348Tcf is there, with a good deal of certainty.
The conclusion is that CHK is probably operating profitably right now and should get better as each quarter passes. An improvement in NG prices will turbo charge the return to profitability.
CHK is truly an enormous operation with more than enough assets to sell to reduce debt. The company has stated that some asset sales that were expected to close in 2012 will be delayed until 2013. I find that a little hard to swallow since they have such a huge asset base, it would seem that they could find a buyer for enough to get the debt problem behind them.
I suspect that:
- perhaps oil production is increasing at such a rate that further asset sales might not be necessary.
- In the alternative, perhaps CHK is negotiating with a buyer for the whole company. Communications from the company have gone "dark." Any potential buyer would want asset sales to stop while due diligence proceeded.
Either of these possibilities is wildly positive for CHK and will be shown to be true or not true certainly by the end of the first quarter of 2013.
I'm buying call options for April 2013 and Jan 2014.