Chesapeake Energy Corporation (NYSE:CHK)
Deutsche Bank Leveraged Finance Conference Call
October 1, 2013; 01:50 p.m. ET
Jeff Mobley - Senior VP of Investor Relations & Research
Gary Clark - Senior Director of Investor Relations & Research
Here representing Chesapeake Energy Corporation is Jeff Mobley. He’s the Senior VP of Investor Relations and Research.
Great, thank you and it’s great to be here. This is always one of the more important debt conferences that we attend; it’s certainly a great venue. I appreciate you being here today. A lot of different options that you could choose today and I’m glad you’ve chose to spend some time with us today.
I’d like to first talk a little bit about what’s going on from a high level perspective at Chesapeake and what really underpins our future success, what underpins your investment, is the foundation of great assets that the company has worked to build, particularly over the last eight years and what we amassed is what we believe is one of the largest, unconventional resource bases in the United States.
And what’s important to distinguish is that we’ve reached an inflection point. We have reached the point where we can finally focus on capturing the efficiencies and driving financial returns at our company, whereas in the past the focus was very much activity based. It was focused on amassing a large resource base and finding ways to fund not only to capture the leasehold initially, but also the holding of leasehold by productions, and the plays that we’re in are both brand new over the past decade.
They required a lot of the initial investment and infrastructure, and as I mentioned, holding leasehold by production and establishing where the best portions are of the play. That’s a very inefficient process, but we’ve reached that inflection point with the vast majority of our core leasehold and the very best plays, largely held by production or a near term plan to be held by production very soon, and so we can rapidly shift towards improving efficiencies. I’m going to highlight a number of ways that we can do that over the coming quarters and years ahead.
Just to give you a brief update on the status for Chesapeake, we have had leadership transitions and we are focusing on a slightly different – well, a drastically different strategy focused on returns, but understand that the key elements for success are in place.
We’ve got a large captured asset base that we believe are some of the very best in the United States, if not the world, and we have a very strong organization with a lot of capability and we have a stable and improving financial profile and we are going to continue to make that even better in the next few quarters. We had very strong results in the second quarter and we’re on track to deliver the results that we’ve talked about for the full year 2013.
Underpinning our new strategy of the company are two key tenets: One is financial discipline, and the other is profitable and efficient growth from captured resources. So what does that mean?
So lets talk about financial discipline. We will focus on balancing our capital expenditures within cash flow and we get a lot of questions on what does that exactly mean? And we are working through that in the process as we design the 2014 budget, and today I can’t tell you if it means that all inflows and all outflows are completely balanced or does it mean that our cash flow from operations runs all of our capital expenditures. The one thing I can tell you is that our program for next year will not be dependant on asset sales as it has clearly been in the past.
More importantly though, to think about what that statement means from a broader perspective over a longer period of time, we are working to try to get all our inflows and outflows in balance and deliver a steady, predictable, measured growth with strong rates of return going forward.
How we are going to achieve that in part is through implementing a competitive capital allocation process. We are cutting out a lot of the inefficient aspects of holding a large leasehold base. Much of it’s already done, so it makes that transition much easier, avoid some value leakage by focusing on holding every bit of acreage that we possibly can.
We are going to focus on a smaller, more focused set of operations and have projects compete for capital and one of the things that is really true about the oil and gas business is the personnel that work in companies derive their work on weather or not wells are getting drilled, if they have a rig on their assets and if you’re an asset manager, you’re a geologist, you’re a geophysicist, you’re an engineer, if those are not assets in your area, your going to do one of two things.
Either you are going to go work somewhere else or you’re going to figure out how to make your project more competitive. You’re going to figure out how to get reserve recoveries up, you going to figure out how to get cost down and you’re going to get cycle times better and our projects will compete for capital.
Now there is limitations of course. You can’t outrun infrastructure. There may be some very valuable acreage left in small portions in core areas; there maybe a few binding constrains with respect to some financial structures that we previously put in place, but by and large you can see a strong competition for capital and a focus on returns.
There’ll also be accountability. We’re implementing a process; compensation systems designed on pay-for performance and asking for capital to invest is like a contract with the company, and underestimating is just as bad as overestimating in our new performance system.
What I mean by that is if you over spend it, obviously that’s not going to be productive to returns, but if you under spend relative to what you planned to deliver, either there should be a commensurate up-tick in performance, meaning reserve recoveries or that’s a negative, because that’s capital that could have been invested further in your particular project or it could have been invested in another project with a high rate of returns. So we’re certainly incentivizing predictability in our business model going forward.
We’ll also divest non-core assets and look at hard and non-core affiliates. That process is underway and a lot of those initiatives will lead to balance sheet improvement, which I’ll talk about further and we still continue to have and we are adamant about achieving investment grade metrics.
And however long it would take to get investment grade ratings from the agencies under our prior strategy, its my personal belief that that timeline, that season period will be much shorter given the shift in our business strategy and the predictability of our business model going forward, than it ever would have been under kind of the prior growth at any cost type of strategy.
Focusing on profitable and efficient growth, we’ve got great cards to work with. We got world-class inventory in some of the best plays, such as the Marcellus Shale, the Eagle Ford Shale, the emerging Utica Shale play, as well as underpinned by world-class gas assets, particularly in the Haynesville Shale. They are fantastic reservoirs, but they do need – that particular one needs slightly higher commodity prices to really optimize the value out of that play.
We’ll also focus on getting our well costs down and we’re taking a lot of different initiatives towards well costs and I’ll tell you about some of those in a few minutes. We foresee continuous improvement and drive value leakage out of the business and lastly, and this is an important concept, in the new op we are not in harvest mode, we are not just in blow down mode in the company. We are focused on growing profitably and efficiently.
But in contrast to prior strategies, if there’s a new play to pursue, a new opportunity to achieve, it’s going to have to compete for capital and knock something out, rather than just adding to the overall program, so the concept of substitution rather than addition as we continue to grow our business.
Some near term priorities are to implement a capital efficient – an efficient capital allocation process. We talked about that a little bit. Our 2014 budget will not be dependant on asset sales. We’ll capture supply chain efficiencies in ways that we’ve never done before.
I think we’ve been pretty good by growing in HBP and acreage, in a way that is not very logistically efficient and working at an extremely high pace, we weren’t really able to capture all the supply chain efficiencies and economies of scale that we can. The purchasing power of our drilling program is enormous and we’ll place an increased focus on trying to capture some of the value.
Reducing our well costs, we’ve been pretty good, but not anywhere near as good as we can get and to my estimation, we’re easily two, if not three or maybe more years behind some of our competitors in the efficiency curve and that’s the fact that we’ve just had more leaseholds to hold than other companies out there. But we can get much more efficient and we will, leveraging the first well investments that we’ve already made in our existing plays.
By multi-well pad drilling we can save 15% to 30% on our well cost, just by eliminating the first well cost, such as new roads, the well pad, water impoundment facilities, treating facilities, gathering connections, all of the things are borne by the first well and we will continue to drive those costs down.
We’ll also work on reducing financial obligations, whether its to drilling programs that aren’t as efficient as others. One of the things that you can expect from us is to reduce financial complexity over time and that will come with proceeds used from asset sales to eliminate some of that complexity and any type of initiative that would incentivize is a high level drilling activity that outruns the asset teams technical ability to executive. We’ll try to dial those situations back, so that our capital program is even more efficient.
When Doug Lawler joined the company, we initiated a comprehensive review of the company. We expect to have that review largely, if not entirely, complete by November 1 and we really looked at every aspect of the company. We looked at our organizational structure, we’ve looked at our overhead, we’ve looked at our LOE cost and our filed operations approach, we’ve looked at our portfolio and our financial planning process and reviewing our non-core affiliates and what we’re trying to do is reposition the company in a way that is much more efficient.
We have reorganized the business into two different business units, supported by drilling and technology services, and the rest of the organization will support the two different business units and those business units will be accountable for delivering the financial performance and that will be incentivized through our performance compensation system.
We have tremendous opportunity to reduce our income statement cost, whether its LOE or overhead. Just think about the size of our organization today. We have about 6,000 employees. It was designed to be able to executive a drilling program of 175 rigs at our peak; actually it’s 170, with the capability of running as many as 200 rigs. Today we are operating 61 and so you’ll see some pretty meaningful changes in our overhead structure as we work through how to optimize our business and the size of our organization geared towards around a 60 to 80 rig drilling program for the foreseeable future.
We also have tremendous opportunity for field operating cost improvements and lease out operating expenses. We’ve actually been pretty good when you compare it to a lot of our peers, but the opportunity set for us to get better, whether its reducing downtime, increasing logistics, striving efficiency into the system, working with our supply chain; there’s many opportunities where we can drive our lease operating costs lower, and we’ll have a financial planning process, so that’s a lot more predictable and optimizes our financial returns.
The next slide I think is pretty insightful about the opportunity set for us to improve, because a tremendous amount of capital is invested in 2010 through 2012. That adds up to about $40 billion of capital and that capital wasn’t necessarily always as efficient as it could have been, but for a lot of really good reasons it was holding leases that may not generate value for several years, but it wasn’t generating an immediate rate of return, but that investment and that work has already been down.
The drilling CapEx that you see in blue, a lot of capital was spent to drill wells that may not come on product for a year or two years and so the cycle times of that capital, the building of backlog wasn’t necessarily capital efficient, but it was very important to do to lock down a very viable resource base.
But we’ve reached that inflection point as I mentioned at the start of the discussion today, and now we have the ability to reduce those costs substantially and generate more immediate rates for return.
Just this year alone we reduced our total outflow of CapEx by about 46%. Its much more focused on just E&P operations as we’ve exited the mid-stream business; we’ve completed our growth investments in the oilfield service business, and we’ve largely completed the build out of our overall corporate campus.
So not only has leasehold spending, which is the light green bar, been reduced down to a pretty minimal level of roughly $350 million this year, perhaps a similar number next year, but our other CapEx besides drilling and completion of $1 billion this year, could easily be reduced by half next year, as we continue to focus our capital on just our core E&P operations.
Slide nine is a fairly new slide, and I think it really helps articulate the opportunity set that we have to really drive returns much higher. If you just look at 2010 through 2012, about 75% of our drilling program was single-well pads, and Doug, while our new CEO kind of coined the term of, Chesapeake in that period grew by brute force and we generated one of the highest growth rates in the industry.
But it was also the inefficient process of single-well pads in varied locations to meet a lease expiration schedule, a drilling program designed more around the land requirement than the geophysics and engineering departments and we reached that inflection point as I mentioned, and this year only about half the wells we drill are on single-well pads and by next year it will probably be 20% to 25%. Meaning that 75% or so of next year’s drilling program can be our multi-well pad, where we can reduce well costs by 15% to 30% and we can greatly reduce the cycle times.
If you just get over 20 feet and drill the next well, that’s a lot easier than breaking down a rig and moving it several townships away to be setup and drill another single-well somewhere else.
Also the completion time and cycle times can be much more efficient, where we can focus on completing several wells in a single pad rather than breaking down the tanks and the pressure pumps and all the other infrastructure associated with completing wells. So we’ll be able to achieve a number of different efficiencies going forward and we are pretty excited about those opportunities.
Eagle Ford is a good example of that whole process. Today we have about 10 rigs in the play. That’s down from probably 20 rigs or so of roughly a year ago and some of that is from asset sales. We sold the northern portion of our acreage and largely in Zavala and Frio Country, and that represents about four rigs out of the program.
But through better cycle times we are actually able to reduce the rig down and still get our planned number of wells drilled. We have about 75% of this acreage held by production and there should be no challenge at all to have the core portion of our acreage held by early 2015 with a reduced drilling program.
This next slide is one that maybe a little surprising to some of you if you were to take a quiz. I don’t know that many of you all would or many investors I talked to would be able to say who is the second largest producer of oil in the Eagle Ford Shale is. I think everybody knows that who the largest produce is, but I don’t think they’d recognize Chesapeake immediately as the second largest producer. But that speaks to the quality of the asset and the quality of the operations in that particular play and we do have the fastest growth rate in that play and we’ll work to continue to grow that in a very efficient manner.
Utica is an emerging play for us. We are extremely pleased with our opportunity set here as we start to ramp up production now that the infrastructure has been put in place. We’ve largely been responsible for about 70% of the drilling in the play to-date. We’ve drilled more than 300 wells. I think it’s north; it’s approaching 350 wells to-date, and just over 100 wells are in production and most of those are at restricted rates.
But as the processing capacity gets put in place, we’ll be able to ramp up production through the end of the year. There has been a slight challenge with a fire at Blue Racer's project at Natrium. Not exactly sure how long that will be offline. That could temporarily inhibit our ramp-up in production. But we are really pleased with the quality of the assets here and looking forward to ramping up as the processing gets online and well gets to really produce at its fully capable rates.
Marcellus is another great asset for us, and what I like about this particular side is it illustrates our opportunity set in the whole company. The red acreage here is some acreage that we sold, that didn’t have a higher value per acre. It was fairly scattered and it was more valuable to somebody else than to us. Its acreage that we may not have ever drilled, or if we did it would have been several decades out.
So it make sense to high-grade our portfolio, to sell off non-core assets and that’s what we accomplished earlier this year in the north with Southwestern Energy and in the south with Equitable.
But we also retained a very valuable acreage set inside of the blue line, but most importantly though, there is an enormous opportunity set in what we call the core, the core which is some of the very best rock in the Unite States for shale gas production and maybe some of the best rock in the world and we’ve got the largest majority of that. Cabot would be the other company that has a great potion in Susquehanna County.
This is where our opportunity set for our portfolio improvement really takes hold. For example, if were to drill wells, say in Bradford County, that could be a 5 to 7 bcf well. But if all of our drilling program is focused in just the green area, that could easily be wells that are 9 to 12 bcf and that’s where the focus of our drilling program will be.
We believe we have about 100,000 acres in that core, of the core area, representing 1000 locations and perhaps depending on our pace of drilling on an eight to 10 year drilling inventory at very, very high rate of returns, and that’s before we get to the pad drilling efficiency that I earlier alluded to.
Shifting on to results this year, we are having a very strong year aided by continued growth. Also an improvement in commodity prices and we’ve achieved this with a 46% reduction in CapEx, which you’ll note that even with that reduction in CapEx, there’s only been about a 15% decreases in net wells turn to sale. So we are getting more efficient and we should be even more efficient next year.
Turning to our financial profile, I think many of you guys are fairly familiar with our approach on having the largest component of our long-term debt placed in the high yield market with fixed long term maturities of rates that have been attractive to us. But we’ve also had some other things that we want to focus on as we reduce our financial leverage and reduce our financial complexity.
Our asset sales goal for this year is $4 billion to $7 billion. We’ve essentially completed or are close to completing the low end of that. We still have ambitions to get into the range and perhaps to the high end of the range and if are successful in doing that, we would take those proceeds and look at ways to reduce our leverage and financial complexity. That could be – a portion of which could be targeted to our subsidiary preferred investments.
We already have successfully started to reduce those earlier this year with a $200 million transaction. Perhaps we can work those out of the portfolio over time. I think we can also look at some of our aspects on the senior note profile and our term loan is callable on November at 102. That’s represented I believe by this dark green bar here and then over time I think you can look for us to take proceeds from asset sales to reduce financial leverage.
We are not yet ready to state a particular target, but we want metrics that we think can stand up to investment grade ratings and that’s depending on the agency you want to talk to. Some ratios to think about would be debt-to-EBITDA below two or at/or below two and debt to approved reserves somewhere in the $0.40 range and that’s where we will target.
So what to expect from us going forward is reduce capital intensity, a top quartile operating metrics, reduce capital intensity, grater predictability on our business and balance sheet improvement and lastly and one of the most prevalent questions that my colleague, Gary Clark who is with me today and I have been receiving over the last several months is what will our 2014 guidance look like and when will we provide that and our goal is to provide that either late this year or early next year once we’ve completed the overall internal review process and how the budget approved through the board.
To wrap things up, we are really excited about the opportunity set, the number of levers that we have to pull, to enhance our financial and operating performance, to improve our balance sheet and improve returns to really all stake holders and hope you guys have been able to participate in some of that this year.
So with that, I think we have time for a few questions.
Please comment, (Inaudible).
Sure, sure. Just for those on the webcast, the question really relates to the ongoing evolution in our company and the industry about the rate of technology improvement in the industry.
It’s a very good question and in a way it also kind of underpins what may happen to supply, both those natural gas and oil and how that may affect price of goods. It’s a really good question to ask.
The breakthroughs of completion designs and lateral length and bit design to drive down well cost, all of that’s been constructive. I think efficiency gains and kind of lean manufacturing concepts and process improvements, goes a lot to improving returns.
From a technology standpoint, I think the opportunity set really focuses on increasing recovery rates. The rock that we drill in today is very tight and in some respect it’s a lot of gas and poor quality rock and so you have to apply a lot of techniques to get those recoveries up.
But you may have a single digit percentage of recovery in say an oil play and if you can get 3% or 4%, 5% of the hydrocarbon more on the plates, that’s a 50% increase in recovery in some instances. So I think those are some of the emerging technologies that many people are working to try to pioneer. Predicting when somebody will crack that particular code I think is particularly difficult, but that’s really kind of the next opportunity set that we can see as a focus on the recoveries.
Outside of that I think many of the other things you see are going to be kind of evolutionary to the business that help optimize performance, but not necessarily revolutionary changes like some new approach on enhancing recovery.
Thanks for your question. Any others?
Well, that means one of two things, either I did a great job and everybody understood it perfectly or everybody is confused. But anyway, I hope you enjoyed the presentation. If you guys have follow-up questions, feel free to contact Garry or myself. Thanks.
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