Chief executive Aubrey McClendon of Chesapeake Energy (CHK) portrayed a potentially massive natural gas field in the Haynesville Shale formation of North Louisiana and East Texas in a conference call on July 2. Declaring that the data strongly suggest ultimate recoverable reserves of 250 trillion cubic feet (tcf), he envisioned 40,000 wells covering an area equivalent to a square 75 miles on a side. That amount of future production might be a quarter of all the gas produced in the U.S. over the next fifty years.
Taking account of speculative current market values for undeveloped land, Mr. McClendon builds a plausible value of $150 a share for Chesapeake stock. We keep our estimate of Net Present Value at $80 a share. In either case, CHK has a low McDep Ratio and we like the concentration on natural gas, the undervalued premium fuel. Other companies especially active in the 80% of Haynesville potential not controlled by CHK include buy-recommended Encana (ECA) in partnership with buy-recommended Royal Dutch Shell (RDS.A). If the tentative volumes continue to unfold, it could help make natural gas our most important “alternative” energy.
Evidence that Supply Responds to Price
While we think natural gas price remains below its ultimate worth, it is nice to know that consumers get more supply for the higher price that has been evident so far. After languishing in the 1990s, U.S. natural gas reserves have increased every year in the 2000s to 211 trillion cubic feet at the end of 2006. Now with the development of unconventional natural gas, including that from shale formations, we are seeing that our most promising alternate fuel is good old natural gas. Most of the new reserves in the first half of the 2000s have come from the Rockies, in a geographical extension of the type of tight gas and coal seam production pioneered in the San Juan Basin, still the largest U.S. natural gas field with daily production of 4 billion cubic feet (bcfd) and proven reserves of some 20 tcf. More production from the Rockies awaits new pipelines.
The latest large new source has been the widely acknowledged shale gas, often located closer to market and nearer existing pipelines. The Barnett Shale in, around and under Fort Worth is vying to be the largest U.S. field with production near 4 bcfd. While proven reserves in the field have not yet reached 20 tcf, Mr. McClendon thinks the North Texas Barnett may ultimately produce 50 tcf over the decades.
An Alternative Energy Program That Could Make Sense
Meanwhile the low price of natural gas is telling us the market could be expanded. The Chesapeake chief would like to be able to export U.S. natural gas to take advantage of a $20 a million btu price in Europe next winter, compared to $14 in the U.S. Stretching his imagination further, he points out that $20 natural gas is a competitive $2.50 a gallon on a gasoline-equivalent basis. The cost to retrofit 25,000 gasoline stations to supply natural gas as a vehicle fuel might readily be justified by the economic, environmental and strategic benefit.
Owners of large cars or small trucks worried about the rising cost of gasoline might sacrifice some modest space to accommodate a compressed natural gas tank. Small problem, there are few if any service shops certified by the Environmental Protection Agency to convert latest models to “flex” fuel for the natural gas/gasoline combination. Though we can be quick to fault our political leaders on energy policy, we think our government has tried on natural gas vehicles, but there has been little public support. Perhaps it is time to gear up again - with the economic incentives higher.
Originally published on July 8, 2008.
