Seeking Alpha
Oil & gas, long/short equity, growth, energy
Profile| Send Message|
( followers)  

Summary

  • Chesapeake Energy has built up a huge position in the Utica Shale play.
  • Chesapeake has been growing its Utica output by triple digits over the past couple years.
  • 2015 won't be the end of Chesapeake's Utica growth story, as it has over 5,500 potential drilling locations left in the area.
  • Lower costs, a liquids focus, and its well reinvestment program has more than doubled Chesapeake's return on its Utica operations.
  • Even as Chesapeake moves into the liquid weighted regions in the play, huge natural gas pricing differentials are weakening its earnings potential.

Ohio is home to one of America's best emerging shale plays, the Utica shale. Located right next to the well established Marcellus, the Utica formation offers plenty of upside potential to E&P players willing to take the risk in developing a new area. Chesapeake Energy Corporation (NYSE:CHK) holds over 1 million net acres in the Utica, and has already established itself as one of the premier operators in the region.

Tripe digit growth with liquids potential
From 2012 to 2013, Chesapeake Energy was able to quadruple its output from the Utica, which is guided to grow by an astonishing 300% this year versus 2013 levels. In the first quarter of 2014, Chesapeake Energy pumped out 50,000 barrels of oil equivalent a day, or BOE/d, from the play. As of the end of June that had grown to 75,000 BOE/d, and investors should play close attention to management's comment around Chesapeake's Utica production mix.

When Chesapeake first starting tapping into the play, most of its output was weighted towards dry gas. Starting in 2014, Chesapeake's Utica liquids production really started to take off. By the end of the year, Chesapeake is guiding to produce ~110,000 BOE/d from the Utica, just under half of which will be oil and natural gas liquids, or NGLs.

Going forward, Chesapeake plans on operating seven to nine rigs this year in the Utica. As it continues to develop the play Chesapeake is guiding that the good times will keep on rolling, with output expected to grow by 30% - 60% next year.

Long growth runway
The growth story won't stop in 2015, as Chesapeake sees over 5,500 possible drilling locations on its Utica acreage. To put that into perspective, at the end of March Chesapeake had only 274 producing wells on its Utica position, meaning there is plenty of production growth to be had in the years ahead. By tapping into its huge drilling inventory, Chesapeake thinks it can unlock more than 4 billion BOE of net recoverable resources from its acreage.

To maximize the earnings potential of the Utica, Chesapeake has been improving its operations in the play, and the results speak for themselves.

Higher returns
By reducing the number of days to drill a well from 18 in 2013 to 13 this year, Chesapeake is guiding for well completion costs in the Utica to fall from $6.7 million last year down to $5.7 million by the end of this year. This doesn't factor in the extra cost from its well completion optimization program, which adds an extra $1.4 million per well in return for an 80% return on the incremental investment.

Shorter drilling times, its well reinvestment program, and a focus on liquids production has allowed Chesapeake to generate a 45% rate of return on its Utica wells this year, versus just 20% last year. As its liquids production approaches and surpasses 50% over the next 12 months, expect its returns to keep rising.

Problems remain
It isn't all fun and games in the Utica though, as plenty of hurdles remain for Chesapeake. Due to the lack of natural gas transportation capacity, Chesapeake is receiving a $1.25 - $1.35 mmBtu price differential for its dry gas production from the Utica. Dry gas makes up over half of Chesapeake's Utica production, so even as it continues to develop the liquids rich portion of the formation, its earnings will still be held back until more pipelines are brought online in the future.

Other problems Chesapeake faces is the ability to gather, process, and transport its new crude and NGLs production. Lack of infrastructure could substantially curtail future production, which investors need to be aware of.

Final conclusion
Even with the pricing differentials and the ever increasing need for more midstream infrastructure, Chesapeake's Utica aspirations are very promising. Over the past two years, Chesapeake has posted back-to-back triple digit output gains from the Utica, which will continue on throughout 2015 and beyond. The Utica will allow Chesapeake to further shift its production mix towards liquids at a very fast rate, making it a buy after the recent pullback in its stock price.

Source: How Chesapeake Energy Is Banking On America's Next Top Shale Play