A natural gas glut in the U.S. leading to a drastic fall in prices has embroiled Chesapeake Energy (CHK) in a difficult financial position. It's been in a hurry to sell off assets to meet its funding shortfall, which is estimated to be at $22 billion. Chesapeake is considering selling off several of its fully or partially-owned midstream businesses alongside some gas and oil fields. It recently completed a $2 billion deal give up its 46% stake in its affiliate Chesapeake Midstream Partners - a gas, NGL and oil gathering company.
Chesapeake's core business was natural gas exploration, but management is considerably shifting focus to a balanced mix of dry gas and liquids production to support sustainability of cash flows in future. We have a Trefis price estimate of $19 for Chesapeake, which is in line with the current market price.
Utica Shale - Tremendous potential for future value
The move towards more of NGL and oil is reasonable as oil is an indispensable commodity, at least in the near future, in contrast to dry gas, which continues to be vulnerable as gas and coal jeopardize each other intermittently. Hence, there is a gold rush for reserves likely to hold more of oil than gas or NGL. In January, 2012, the French company Total agreed to partner Chesapeake in Utica Shale reserves JV with a $2.3 Billion investment.
Chesapeake has spent heavily on Eagle Ford shale earlier and claimed that 55% of total production in Q1, 2012 was oil, which bodes well with its strategies. Another promising reserve is Utica Shale, in which CHK holds the largest stake. It has drilled 59 wells in the play out of which 9 rigs are current producing. In its recently published investor presentation, Chesapeake reported 8 of those 9 rigs to be wet gas windows with nearly one-third being oil output, which is relatively high compared to conventional wells. Wet gases typically include ethane, propane and butane. Chesapeake has budgeted nearly 39% (nearly $3 billion) for Eagle Ford and 8% (nearly $600 million) for Utica Shale of its 2013 estimated total capital spends.
There is, however, some doubt about the oil reserves of the entire Utica shale area despite encouraging results from intial drilling. Ohio officials estimates 1.3 billion to 5.5 billion barrels of oil in the play, which could be higher than the Eagle Ford Shale in Texas, which U.S. Energy Information Administration estimates to hold 3.4 billion barrels of oil. Eagle Ford and Utica Shale are the two most prominent oil plays in Chesapeake's strategy to move to oil-based fields.
There are two scenarios with respect to Utica Shale; Chesapeake sells off the majority of Utica to stay afloat (because it's highly valued) or wait for the long-term output profile between gas and liquids. We believe, even if the output profile is not inclined towards oil, the company can still benefit as gas prices will recover by the time those wells start operating. The company has disclosed information about only 8 of the 59 wells dug and has held back information relating to the rest, which could be a strategy if it already knows that those wells are heavy on dry gas. Chesapeake's stock derives nearly 52% value from oil production and 44% from natural gas production, according to our estimates, which could change if we see a sooner-than-anticipated reversal of gas prices.
Disclosure: No positions.