Chesapeake Energy Corporation (NYSE:CHK)
2013 UBS Global Oil and Gas Conference Call
May 22, 2013 11:00 am ET
Jeffrey L. Mobley – Senior Vice President-Investor Relations and Research
William Featherston – UBS Securities LLC
William Featherston – UBS Securities LLC
Okay. If I could ask everyone to get seated, we’ll move on to our next presentation, Chesapeake Energy, which is in the process of shifting from asset capture to developing the core of the core and improving their capital efficiency and monetizing the asset base and, obviously, a lot of news earlier this week with in addition to their leadership team. We have Jeffrey L. Mobley, who heads the Investor Relations team here to tell us about it. Jeff?
Jeffrey L. Mobley
Thank you, Bill, and I appreciate all of you joining today. I guess before we get started, I think it will be important to acknowledge some of the events over the past few days in Oklahoma City, where some pretty devastating tornadoes that went through various parts of surroundings around Oklahoma City. I’ll let you know that the Chesapeake campus was certainly intact, but the lives of lots of our friends and colleagues have been affected, in fact, my assistant had her house completely destroyed.
And what I have been impressed with is the amount of outreach that we’ve received for people who want to help Chesapeake donated million dollars to the Red Cross to help them release efforts, since learned that other companies have donated substantial sums too. So if there are others who have an interest, we are happy to help direct folks to resources that are in place. Chesapeake is also helping with heavy equipment to help them recovery efforts, we have boots on the ground and we’re working for to doing all that we can to help with that, so just wanted to acknowledge that before we get started.
Now moving on to our slide presentation was obviously less important in today’s circumstances, but I wanted to highlight certain things that we’re working on. And our company is uniquely positioned to really execute and create a lot of value. We spent the better part of the last two decades building what we believe is one of the premier and one of the largest resource bases in the U.S., and that’s come through a very diligent and dedicated execution of a strategy focused on new play identification and asset capture, a lot of capital was spent, building leaseholds and that also required incremental capital to drill first wells on leases to retain that valuable asset.
And much of that work has already been done. And that work also required frequent funding requirements whether it’s capital markets’ issuance of debt or equity or oftentimes asset sales that effectively work portfolio management to high grade our asset base and fund, the ramp up of drilling in various plays, but where I’m really pleased or what I’m really pleased to talk about is where we are today and that’s what we call the value realization process and it’s a combination of what we’ve spent the last decade trying to do.
And now we’re at that inflection point and I think that’s important takeaway for you today is we’re at that inflection point, where we can focus on developing your existing assets. We can focus on operational efficiencies. We can focus on return on capital, and we’re planning to have a substantial amount of financial discipline going forward. Also this week, there was a new hire to our team, our Board has selected Doug Lawler from Anadarko to lead this value realization phase and we look forward to working with Doug in executing that and I think from my understanding, there’s no anticipated change in strategy.
So we’re working on being able to deliver that in the months and quarters ahead. So what does the strategy shift mean? On developing assets, we’re going to focus on the core of the core. We’ve got a very large resource base. And now that our leasehold base is largely held by production in most plays, including the Eagle Ford by the end of this year, we can go back and drill our best well next and pick locations that are not determined by a person from the land department that is focused on our lease exploration, but rather focus on the best rocks in a particular play that geologist and geophysicist and engineers would help determine. And that will have a substantial improvement on our return on capital.
We’ll also continue to focus on liquids plays until gas prices rise to a level that competes for capital with our liquids plays and that will lead to a substantial amount of margin expansion of our company. Along the way we’ll optimize our portfolio by selling non-core assets to bridge a short-term funding gap for 2013 that’s about $3.5 billion. We‘ve got very good line of sight to how we fund that funding gap and then we get to work on balance sheet improvement in the second half of the year, much of the low end of that range will be focused on assets that are non-core to us and we’ll be able to optimize our portfolio.
We will also focus on operational excellence, focus on safety, compliance, process improvement, the cycle times and other things to really improve returns on capital. Also pad drilling efficiencies will have a meaningful impact anywhere from 15% to 30% improvement by shifting the pad drilling. We get to capitalize on the first well investments such as $1 million road or $400,000 well pad, our existing treating facilities and gathering infrastructure among other things and that should really be able to boost our returns on capital. We’ll focus on returns and also focus on eliminating financial risk and over time, we’ll focus on reducing the complexity of the structures that are put in place to fund the asset base that we put together.
In terms of financial results, we are pleased with what we’ve reported for the first quarter, strong growth in earnings and cash flow. Our liquidity position was strong. We made great progress in our asset sales now $2.3 billion of assets signed or closed at $4 billion to $7 billion target for the year. And our upstream capital spend was down substantially to keep cash flow and CapEx more in line with where they’ve been historically.
At the same time, we have been able to deliver strong operational results. Total production growth was up 9% and that’s inclusive of the results of various asset sales, liquids mix continues to improve. We are at 24% as of the first quarter and you can see that continuing to steadily take up over the coming quarters. Oil production was up 56% and from a large base, which I think is quite noteworthy.
At the same, our gas production is relatively flat and will remain so until gas prices recover to a level that incentivize drilling and importantly we achieved the milestone operationally also on the safety front having recorded. 1.5 million man hours without a recordable injury, which is a standard of excellence in the industry.
We’ve talked about focusing our efforts on existing leasehold positions. And I think we’ve talked this and people know we are focused on ten key plays. But what we also challenged our new ventures team is to focus on other horizons on existing assets and to the extent that we find anything that’s noteworthy and commercial. We probably won’t talk about until we have a large enough samples that to prove its commerciality. But the key takeaway for you also is that if our new ventures team find something, we don’t anticipate having any new land expenditure to capture it, because we’re going to focus only on our existing asset base.
Over the past few years we have been steadily decreasing our natural gas rig count and we expected to stay fairly low as I mentioned. Oil rig count has been moderated not because the return profile has changed, but only to keep CapEx more in line with cash flow. And our liquids spinning is now approximately 85% directed towards the liquids plays. And that’s resulted in a stronger growth and about five percentage point increase is in our liquids production mix each of the last few years and we expect that to continue over the next few years.
By play, just to give you a sense of where our capital is being directed, the biggest spin this year is in the Eagle Ford Shale powered by the greater Anadarko Basin, very much liquids-rich plays. About 11% of our capital net of the drilling care from Total is in the Utica Shale play and only a small percentage of our capital is in the dry gas plays that I would note that only about four rigs are working in the Barnett and Haynesville, which are really the only two plays that are not very economic in today’s environment.
In terms of liquids production mix, as I mentioned, our gas production profile is flat, but that’s only because of the growth of associated gas from our liquids plays. Our shale plays are in decline and that’s inclusive of the strong growth that we’re getting out of the Marcellus Shale. All of our growth is from the liquids plays and that was leading to the margin expansion and we still maintain our target of 250,000 barrels a day of production – liquids production by 2015.
In the Eagle Ford Shale, a lot of the great things are going on in the play. We are in the process of selling the northern portion of our Eagle Ford Shale; we hope to be able to share that with you sometime in the next few weeks or months. And what we will retain is a very large position that represents about 3,500 future drilling locations or about 10 years worth of drilling and what we call the core of the core. It’s a very liquids play and we’re just now in the process of starting to deliver significant efficiency gains as the play gets held by production.
To start this year, only about 15% of our rigs working in the play were drilling on pads, everything else was on a new pad rather than an existing pad. By the second half of this year, approximately half will be on pad development and probably somewhere in the neighborhood pf 75% to 80% will be on pads next year. That will drive a lot of efficiency as we can then go back and focus on the very best rocks and capitalize on first well infrastructure.
Our spud-to-spud cycle times are down substantially and why you see our rig count going down in the Eagle Ford, it’s only because we’re getting better at what we do and drilling the same number of wells with fewer rigs. and this year, we still intend to drill approximately 300 wells, while at the same time, we’ll work off inventory and turn on about 400 wells in the play and it’s probably something similar to that for 2014, likely be the program.
We’ve also tried to provide some more information to help folks better understand the asset quality of where we put together, we’ve unveiled economics of what we believe we will retain in the core of the core Eagle Ford. We’ve drilled about 500 wells and illustrated the estimated reserves from those wells in the upper right-hand corner of the slide and very strong results of approximately 540,000 barrels a day equivalent is what we’ve achieved to date. And this is, obviously, pre-royalty and on a gross basis.
I think when you compare to other operators, these will compare very well, but also I would note from the type of development, we generally drill a little bit longer laterals than some of our peers, which leads us slightly higher well costs. We are currently at about $7 million in well cost, but as we shift more to pad development, we think we could see well cost go to $6.5 million and perhaps six over time. And what that does in return is generate a well that pace out in approximately two years and assuming $90 oil that’s about 40% rate of return, and we have 10 years of drilling to do in this play at that type of return, pretty sportive play in our view.
The Utica Shale, we’re very excited about, it’s still very early in the play. our production today is currently about 65 million cubic feet a day on a net basis. We expect to ramp that up to about 330 million by the end of the year as additional processing capacity comes on line. I believe the Natrium facility is coming on line right about now and mid to late summer we should have incremental processing capacity at Momentum’s plant at r Kensington in Columbiana County. And that should also lead to strong growth.
I believe the State of Ohio put out some well information out recently that I guess is a date point. It’s our view that’s not very helpful data point in assessing the quality of the play. We talked about that a little bit on April 1 conference call. But most of the wells that we brought on line to date are at a very constrained rate.
A lot of the wells that have been built in your existing infrastructure are drilled at more gassy locations because that’s the infrastructure takeaway capacity that was available. But we are pretty excited about our opportunities that here that we are projecting EURs of 5 bcf to 10 bcf per well, the larger end will be more gassy wells, the smaller are probably more liquids-rich wells with higher economic value per mcf. We are currently operating 14 rigs in the play and we will continue to develop that with the benefit of a drilling carry from Total that will last at least through the end of 2014.
The next slide highlights where some of that infrastructure is located. The dark green is the infrastructure that we’ve contracted to process Utica gas. The dark blue is what we’ve contracted to process wet Marcellus gas and the light blue is third party facilities. You might also note that strong footprint we have in the wet gas window of the play that’s represented by the purple outline, which is the AMI with Total. And what I tell you we’ve learned about the play is that it’s turned out to be more productive further south than what we originally estimated. And it’s also turned out to be a much better in the dry gas window what we had originally thought.
And on that note, on the dry gas window, it’s our view that the dry gas play may compete with some of the wells that we’re drilling in Bradford County and with very, very similar returns. Also I’d note the red line on this map is the ATEX Pipeline, it’s a white grade line that allow us to export a lot of the light end of the liquids stream, beginning I believe in the first quarter of 2014.
The Greater Anadarko Basin is a area that we continue to have success. We’ve drilled horizontal wells in more than a dozen different horizons and the basin continues to yield strong success and plays like the Granite Wash, the Cleveland, Tonkawa play, our Hogshooter where we’ve drilled some of the largest onshore wells, oil wells in the industry lately. And also it’s where the Mississippi Lime play is located.
We hope to close our joint venture with Sinopec this quarter. That’s where we’re selling at 50% interest in the play for all cash with no drilling carry. And it’s a play that we’ll yield very steady, strong results for us. And one of the things that we’ve learned in the play is that if we drill at a slower pace, we’ll like to have stronger returns as the play is not a resource play, it’s not statistical, it’s one where we need to do the geologic and geophysic work to pick the proper locations and that’s already yielding results with stronger reserves for well then we’re achieving at a faster pace.
On the Marcellus Shale – advancing the slide here, on the Marcellus Shale here, this continued to be an outstanding asset for us. Our growth in the play will be limited by takeaway capacity. We did get an uplift as new infrastructure was put on line late last year, similar amount of infrastructure will be added by the end of this year and that will be another step change in our production profile from the play.
We’re focused on two areas, the northern portion in the play, largely in Bradford, Susquehanna like Wyoming County as well as in the southwestern portion of the play. And what I’d like to highlight here is the northern portion of the play where we’ve recently sold some acreage and I really kind of highlights what our opportunity set is for the entire company just in this one microcosm of the map.
But what we’ve outlined in this play is – a green outline that we call the core of the core, it’s an area where we’ve drilled dozens and dozens of wells and we’ve achieved about 10 bcf on average. These are wells that can generate a 100% rate of return, very, very predictably. We’ve largely held that core of the core by production and we have about 100,000 acres in some of the best shale gas rocks in the world frankly. We have a thousand locations or more remaining in the play and that’s more than a 10-year inventory. And that’s where most of our rigs, if not all of our rigs, will be focused in this play going forward. And the growth will only be limited by infrastructure.
The blue outline represents very good, high quality assets that we may not get to drill as soon as we might otherwise because of our focus on core of the core and while there’s nothing specifically we’re thinking about doing with this particular asset. In other parts of our portfolio, there may be some assets that are very good quality that have more present value to others that to us and that might be part of what we use to get to the mid-upper portion of our asset sale targets this year. But they’re very, very high quality assets.
Also in the red, it illustrates non-core assets that might be scattered, that might be out of the fairway of most likely productivity that also might fit in parts with other companies well on from time-to-time, we will monetize those assets and turn it to cash, a value that’s probably not in anybody’s net asset value model, and in some ways probably shouldn’t, because it doesn’t have any present value to us, because we have no intention on developing it. But if we can extract some capital from that, we will do so from time-to-time.
One thing to be very careful of is just assuming that all acres are the same. Acreage in Eastern Susquehanna County is very different than what is in Southwestern Susquehanna County and keep that in mind when you’re doing net asset value of this distinguish acreage quality. And just real quickly on slide 21, this is the new slide we posted last week to outline our view of the economics from the core that Marcellus, which even that a $4 gas price environment is north of 100% rate of return.
We also want to touch briefly on financial discipline. We’ve always tried to provide a lot of transparency into our corporate model and what we expect to achieve. And this year, we do expect to have continued growth even net of asset sales. More importantly, we have strong growth in our operating cash flow as our margins have expanded with a slight improvement in gas prices but also a continuous shift to liquids plays. This year, we expect to generate about $5.25 billion in operating cash flow.
We will spend about $6 billion on drilling and completion activities and we are clearly focused on hitting and achieving budgets this year. Our land spin is down materially to only about $400 million this year and I’ll note that we only spent $50 million in the first quarter of 2013. Other things that we don’t guide to, but generally speaking, the preferred and common dividends along with capitalized interest adds up to approximately $1.3 billion. And there is another CapEx category of about $1 billion that will be vastly different going forward.
In the past, other CapEx has been tough to guide to and tough for people to model, but it’s going to shrink materially as we’re now completely out of the midstream business. We have finished for now and for the foreseeable future, building out our oilfield service business here in this first half of 2013. In 2013, we’ll largely have completed the build out of our corporate campus. So that other CapEx line will shrink materially next year compared to this year.
And so our funding gap this year is about $3.5 billion and we expect to have that covered very soon and we’ll then get to a focus on balance sheet improvement throughout the balance of next year. And conceptually, what you should anticipate us targeting on incremental sales this year, our assets don’t have a meaningful amount of cash flow, but do have a lot of long-term value, which will use to reduce financial leverage, which will reduce our interest outflow.
So kind of a net impact to cash, in total, it should be fairly small, it will have material improvement in our financial leverage and our financial risk profile. And it’s our hope and intent to take financial risk premium questions, funding gap and liquidity issues kind of off the table permanently.
In terms of financial projections, I’ll let you guys review the slide and tune up your models, but there’s really not much that can do the 2013 prices that will change our cash flow given the level of hedge protection that put in place. But I do want to focus on page 25, which highlights a real shift and how we can improve our returns on capital. Over the past three years, about half of our capital was spent on stuff not related to drilling and completing new wells. It had great values; it just didn’t always generate immediate returns on capital. It could be in leasehold, it could be in the architecture and backbone of the midstream system. But only about half of our capital generated immediate cash flow.
In 2013, about 80% of our capital will be focused on drilling and completion activities. Our drilling, completion and leasehold CapEx will be down 39% on a year-over-year basis. And for 2014, while we haven’t proposed a budget to our Board and it’s not approved yet, it’s likely that you’ll see something similar in terms of percentage of capital allocated for drilling and completion perhaps even higher than 80%, which should really boost our immediate returns on cash flow in addition to the product activity enhancements that we get by focusing on the core of the core and the efficiency gains we get from pad drilling.
Just briefly touch on our leverage profile. we’ve always had a view to have long-term fixed rate debt with target maturities we expect to continue to do that with the asset sale proceeds later this year. We probably hope to retire some debt. The term loan that you see in the dark green is probably one that we would focus on first. and, obviously, the high yield market is that record high levels and at some point, it might make some sense to do some liability management work. But most importantly, what you should takeaway from a leverage profile is, we do want to have absolute debt reduction and we are going to maintain a high level of liquidity going forward.
So with that, I’m just going to wrap it up with a few thoughts on why you might considering either continuing your investment in Chesapeake or adding to an investment in Chesapeake is that we’ll focus on capitalizing on the best assets in the industry. We’re focusing on increasing our liquids mix, we’re benefitting from a recovery in natural gas markets. Absolutely, we’ll have an improvement in capital efficiency. and going forward, you’ll see a lot reduced financial risk and complexity profile from the company.
So with that, Bill, I think we have a few minutes left for questions?
William Featherston – UBS Securities LLC
Yeah. Any questions from the group?
William Featherston – UBS Securities LLC
I’ll start with a quick one. it was a comment you made at the beginning of the presentation with respect to Doug Lawler joining, did you say that there’s no anticipation of change in strategy or as you’re going to have a few months to assess the assets and…
Jeffrey L. Mobley
Well, certainly, Doug will have the full range to be the Chief Executive of the company, but it’s my understanding that the strategy that we’ve developed in conjunction with the board is one that Doug is in full support of and he has been asked to come in and lead that effort to help execute and bring it to fruition.
William Featherston – UBS Securities LLC
Any other questions for Jeff? All right, no.
Jeffrey L. Mobley
Great. Well, thanks for your time, I appreciate your interest.
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