Energy Roundup: Chesapeake Changes Its Plans

Big open on tap; keep your fingers crossed. The market has gone into "hit me with your worst shot" mode and many financial writers are seizing on this as a sign of a bottom. Could be good at least for the Christmas rally this week and next. Oil too is showing fresh signs of life after OPEC’s president said over the weekend that the Cartel is getting ready to "wow the market" at its December 17th meeting. Better come with a big number (>2 mm bopd) and most of that from Saudi Arabia or the celebration will be brief.

Not to be outdone in wowing the market, President-Elect Barrack Obama was busy over the weekend touting the biggest public works project in 50 years akin to the CCC focusing on bridges, roads, schools and the like so maybe its time to take a look at U.S. Steel (X) which has just been savaged since the summer months ($190 to $30 folks!).

Finally, Chesapeake (CHK) did what we were all hoping they would, killing their ill-timed shelf registration and adopting a truly cash flow neutral spending program for 2009. A detailed breakdown of my thoughts and their current valuation can be found in the Stuff We Care About Today Section of the post.

In Today’s Post:

1. Holdings Watch
2. Commodity Watch
3. Stuff We Care About Today - CHK, COG
4. Odds & Ends

Holdings Watch: $10KP trades from Friday:

• Exxon (XOM) April 95 Calls sold (3) for $2.40, down 23%
• CHK December 10 Calls bought (3) for $2.10 with todays conference call in mind.

Commodity Watch:

Crude oil fell a jaw dropping, absolutely unprecedented 25% last week to close at $40.81. This morning crude is trading up about $2 on the following.

• OPEC Watch: On Saturday OPEC President Chakib Khelil said the next round of cuts could be "severe." Khelil refrained from saying just how big the cuts will be but noted that the market should brace itself for a surprise in the size of the cuts and also noted that some analysts are looking for cuts as big as 2 mm bopd. "an output decision that startles markets would help bolster plunging oil rates…The best way is to surprise them," he said.

• Contango Watch: I’ve been watching the steep contango in crude futures for some time now. Here’s a Bloomberg article talking about one of the potential impacts: hoarding. Shell is renting offshore tanker space to arbitrage the near month out month spread. It’s impossible to say how much oil this will ultimately remove from the market but as long as the contango remains in place I would expect more "storage at sea" to take place, temporarily removing barrels from the supply / demand picture.

Natural gas fell 12% to $5.74 last week. I have been thinking gas was trying to form a base in the $6 to $6.50 range last week and despite the drop here I still think it will hold close to $6 before mounting an attack on first $7 this Winter and $8 in early Spring. I think it will become evident that supply from non-conventional sources is quick to fall off as the rig count drops. Industrial demand destruction is the major worry at this juncture and little evidence of it has been seen so far as lower prices for gas seem to be offsetting a crimping of consumption due to lower manufacturing activity. Gas has been trading off another $0.20 since the start of trading in Asia but I would expect a colder than anticipated week last week and forecast and the rally in crude to yield at least a small rally after the open.

• Weather Watch:
  • Last Week: Colder than expected. HDDs of 192 vs 177 normal and 194 in the year ago week. The forecast had been 175. This 192 reading should result in a withdrawal north of 80 Bcf this Thurday.
  • This week’s HDD forecast is not yet available but an Arctic surge is predicted this week and it is expected to be colder than the last two.

Stuff We Care About Today:

CHK Reduces CapEx, Shelves Its Shelf.

Capital Budget Reduction:

• Drilling budget falls by another $2.9 billion for 2009/10. Rig count will fall from 130 at present to 110 to 115 by early 2009. This is down from a peak of 158 this past summer.
• Acquisition budget falls $2.2 billion for 2009/10. They are really putting the brakes on buying acreage which should be welcome news to analysts.

Reserves:

• 2009: 13.5 to 14 Tcfe targeted by end of the year, up from 12.1 Tcfe as of 3Q08. Mid point of guidance and a $3 billion capital budget implies a low, low 2009 F&D of $1.20 per Mcfe. This would be an improvement on the $1.35 F&D cost generated so far in 2008.
• Note: 2009 year end would still likely see reserves boosted to close to 20 Tcfe

Production Growth: Falls With Spending.

• 4Q08: volume range unchanged.
• 2009: 5% growth down from 16% previously
• 2010: 13%, also down from 16%

Recent Share Registrations Squashed

• 1St Shelf - Pulled. That’s a potential 6% dilution that won’t be hitting the market.
• 2nd Shelf (the so called acquisition shelf). Cut from 50 million shares to 25. This will be used from time to time to pay for lease hold acquisitions. If all 25 mm shares were issued this would represent 4% dilution.
• ZComment: People obviously hated these deals. Before the today’s conference call was announced last Friday, the shares had fallen 51% since the November 26th close, when they announced the stock offerings.

Asset Monetization Update:

• VPP #4 - Midcontinent - $450 mm for 100 Bcfe (or $4.50 per Mcfe vs CHK’s $1.20 per Mcfe F&D cost). They expect to close this one by year end.
• S. Texas deal is off line. This is now expected to become VPP #5, with a closing date in 1Q09 and a price tag of $450 mm for 80 Bcfe ($5.60/ Mcfe).

Hedge Update:

• 2009: 76% of expected gas production hedged $8.20. Only 12% of this hedge position is in the dreaded knockout swaps and those concentrated late in the year.

Closing Thoughts:

• Reserves / Production: 16 years (that’s pretty long and getting longer)
• P/ 2009 CF = 1.4x. Very low, in fact, in unheard of territory. This is using CHK’s new numbers which should be pretty easy to beat and pretty solid given the large hedge position taking a majority of the sting out of lower natural gas prices.
• The Street has CFPS of $8.84 for 2009 at present and this will have to come down about 8% to get to CHK’s new ‘09 numbers, but again, the stock price has already discounted a much worse scenario at this point.
• This is pretty much what I was hoping for. Shelving of the primary shelf being key. I’m not surprised by the hit to production and think they have set a very beatable bar given the productivity of the Haynesville Shale. I would have liked to see mention of regional gas curtailments but maybe we’ll get color on that on the conference call.

Conference Call: 9 EST, available in the "Events" portion of the "Investors" section of their site at www.chk.com.

Other Stuff Today

Cabot Oil & Gas (COG) Reporting Proppant Shortage. Said they are actively seeking deals on proppant for completions in E. Texas. Notable for the likes of CARBO Ceramics (CRR) - ($62 down to $35 in the last 3 months). CRR has recently re-opened a proppant manufacturing facility in Louisiana to meet unprecedented demand and despite this the stock has fallen with all other service names. As gas prices have fallen and the rig count has come off the drilling population has also shifted to the higher return shale plays, many of which seem to perform better with ceramic proppants (higher strength, better flow characteristics than beach sand).

GMX Resources (GMXR) Trims Budget, Still Set to Grow Nearly Trip Digits Next Year:

• JV with PVA put the breaks on in 2H08, causes company to shave 4q08 volume guidance from 13 to 12.5 Bcfe. This may cause a hiccup in the stock early but it’s a non-event.
• 2009 buget cut 45% due to world-wide gloom and lower gas prices
• 2009 production guidance now 93%. Speaking to conservatism here, the production growth profile assumes their Haynesville horizontals begin production at 3.4 MMcfepd, not the 7.7 IP of the first well and nothing like many of the 10+ IPs other Haynesville players have recorded.
• On last year’s proved reserve numbers these guys trade at $1.14 per Mcfe (see those asset sale values CHK is talking about above, this is 1/3 of that) and there is little chance these guys are worth less than $2 even at current pessimistic sentiment levels which would put the stock at $38, not the $18 it currently trades at.
• Low debt name with big reserve potential (at least 3 Tcfe) and they will be a juicy target when the credit markets free up.
• They speak at Southcoast tomorrow at 3:20 EST

Odds & Ends

Analyst Watch: Devon (DVN) upped from Hold to Buy at Jefco in one of the few recent instances of spine growing-itus on the part of the Sell Side.

Comments

[BrotherMaynard:]

What happens to CHK if nat gas prices go to $4?

$3?

If you can't answer those questions, you shouldn't be investing around CHK.

2008 Dec 08 05:00 PM

[Mmarrkk:]

Well, lets see: at $4 nat gas, CHK will sell 72% of its production for $8.52. At $3 nat gas, CHK will sell 72% of its production for.....$8.52. All of the knock out hedges have been restructured and don't start hitting until late 2009 so gas would have to stay low until then for them to take effect. And they only represent 10% of the 72%.

So short answer: instead of making $2 B next year in profit, CHK may make $1 B IN PROFIT.

If gas makes it to $3, you'll see rigs cut to 1/2 of what is drilling now. Given the nature of the new Shale Gas wells being drilled, they lose 70% of their production rate within the first year of production. Without new wells to replace them, production in the US will drop precipitously. When we lose a few BCF/day in capacity, what do you think will happen to gas prices? Hmmm? While I doubt you'll see $3 gas, if it does come it will not linger there for more than a month or two and then go whipsawing back up. Nat Gas supplies are almost 50% made up of unconventional gas plays...meaning very very high decline rates. Stop drilling and the bottom falls out. Watch and see what happens this spring!

2008 Dec 09 09:22 AM

[XRTrader:]

Great article. Great post directly above.

Few people seem to understand that CHK (altho burdened with debt), has stabalized cash flow and profit with hedges and maintains a great portfolio of assets even after recent sales/monetization (which, incidentally netted about 9 billion in gains). Also, proven reserves should increase considerably next couple quarters.

The only way you should rationally bet against CHK is if you believe that nat gas will go down and stay down for 2+ years. Although, as pointed out above, supply destruction at this price level would be considerable and likely drive prices back up (unless, demand was non-existent).

Stock should be worth at least 24 given today's prices. At 10, it was a STEAL.

Hopefully management will keep it's eye on the ball. Again, great post!

2008 Dec 09 09:13 PM

[BrotherMaynard:]

via morningstar:

"Under a low scenario of long-term natural gas prices of $5, we believe Chesapeake is worth around $8. In this hypothetical low case, we expect production growth and capital spending to drop considerably and costs to moderate. We also think that the firm's projects in Appalachia, Fayetteville, and Haynesville would become top priority given their superior economics. In a high side case of long-run natural gas prices $10, we anticipate that growth would kick into high gear, with cost inflation to follow. Under this scenario, Chesapeake is worth around $145."

I'd rather buy a lottery ticket.

2008 Dec 11 11:58 AM