Chesapeake Energy Pre-Call Notes: Another Quarter, Another Beat

| About: Chesapeake Energy (CHK)

Chesapeake Energy (NYSE:CHK) - July 31, 2008 Close of $50.15  (the stock was actually higher ($50.93) before they announced  earnings results)

In A Nutshell. Chesapeake reported better than expected top and bottom line results with production exceeding the top end of CHK’s guidance and CFPS exceeding the top end of the Street’s forecast range. Costs were in line with guidance and reserve metrics were again better than expected.  They hit the high points in the main basins and released a little more Haynesville data including the first production projections but we should get a lot more color on the call. They did not talk about their oil shale activities but oil production continues to creep up…hopefully more color on the call there as well but it looks like Aubrey will continue to play that one close to the vest until his acreage is place or he’s outed by a competitor.

The 2Q08 Numbers: 

  • EPS of $0.89 (ex items) vs $0.88 expected
  • CFPS of $2.77 vs $2.37 expected, beating the top of the range of $1.94 to $2.68
  • 2Q08 Production of 2.328 Bcfepd (still 92% gas), vs guidance of 2.26 to 2.29 Bcfepd. On an apples to apples basis (netting out the impact of volumetric production payments) this is up 5% sequentially and up 29% from 2Q07.
  • LOE (lease operating expense) of $1.03 / Mcfe vs guidance of $0.95 to $1.05. Per unit LOE is up 5% from the first quarter but they maintained prior guidance for the out years with assumption being that higher volumes offset increased electricity and other expenses.

 Reserves Update:

  • 12.17 Tcfe, up 11.48 Tcfe, up 700 Bcfe from last quarter and up 1.3 Tcfe (1,300 Bcfe ) from year end 2007.
  • 1H08 reserve replacement: 410%. This is the amount of reserves they find or acquire relative to the amount they produce.
  • Drilling and Net Acquisition F&D: $1.49 / Mcfe.  That’s just stunning. During the first half of 2008 they sold reserves for an average of $5.53 / Mcfe in the ground but they bought reserves for a lowly $1.44/Mcfe.
  • Their drill bit only F&D costs for the first half were $1.89 Mcfe. Again, very strong.
  • They continue to guide for reserve growth to 13 Tcfe by YE08 and 15 Tcfe YE09. Given recent performance and well results described below these numbers appear to be in the bag.

CHK Now The Largest Producers of Natural Gas In The U.S. This is worth mentioning only because they are maintaining cost discipline. Growing an E&P company’s volumes just for the sake of growth is non-sense. If you don’t gain efficiencies out of it, like the ones you obtain, from being the first or second most active driller in the plays you dominate, or generating substantial cash flow which allows you to dominate new plays and obtain first mover status, then why bother being big, especially if you let your costs run wild. In Chesapeake’s case, they are obtaining these efficiencies and beating the competition to the core assets before the plays take off….so congrats to Aubrey on obtaining the #1 spot in gas sales.

Transactions Update: Another VPP. CHK float another Volumetric Production Payment, monetizing 93 Bcf of long lived but low upside Anadarko Basis reserves for $605 million or $6.50 per Mcfe. While the ratings agencies may consider this a form of stealth debt, I would point out that they lack an understanding of both time value of money (monetize it now) and a good deal when it is starting in the face. Putting that capital to work in inarguably higher projects like the Haynesville, Fayetteville and other shales makes a world of sense.

Volumes Guidance:

  • 3Q08: 2.36 Bcfepd, up 1.4% sequentially…given where they saw production volumes are in the Barnett at present, this looks like another easy beat.
  • 2008: 2.36 Bcfepd, up 21%. Same as prior guidance. I would point out that they did not reduce annual guidance for the 50 MMcfepd of production that goes away with their sale of their Woodford Shale assets to BP or the 50 MMcfepd of production associated with the Anadarko Basin VPP outlined above.
  • 2009: 2.81 Bcfgepd, up 19%. Same as prior guidance.
  • 2010: 3.34 Bcfepd, also up 19%. Same as prior guidance.

Operations Update: The company only provided a handful of highlights.

Barnett Shale: Now producing half a Bcfgpd net; 2008 exit rate climbs

  • 2Q08 avg net production of 466 MMcfepd up 13% from the 410 MMcfepd 1Q08 average and up 125% vs 2Q07.
  • current production is 500 MMcfepd net (yep, half a Bcfgpd) and they are targeting 675 MMcfepd for a 2008 exit rate. This exit is up from 650 MMcfepd as of the 1Q call.
  • They have 45 rigs running, up 4 from last quarter and complete a well in the play every 14 or 15 hours.

Fayetteville Shale: Booming

  • net production averaged 136 MMcfepd in the quarter, up 425% YoY
  • currently producing 150 MMcfepd and targeting a year end of "at least" 200 MMcfepd (0.2 Bcfepd)
  • operating 17 rigs now and moving to 21 by year end
  • no per well economics divulged in the press release this time

Haynesville Shale Play: Northwest, LA.  More well results and the first volumes projection.

  • Acreage now at  450,000 acres and still acquiring
  • 11 horizontal wells producing 45 MMcfepd gross, 35 net.
  • Setting a year end exit rate of "at least" 75 MMcfepd gross
  • Latest well, the Milton Crow 27-1H, is producing 14 MMcfepd, 5,800 psi on a 24/64 choke, no completion details given and I don’t expect to hear much in this regard on the call
  • 8 rigs in the play (up from 4 as of last quarter), moving to "at least" 12 by year end. This will put them on track to completing one Haynesville Shale well every five days. Someday, given their history and their confidence in this play, this distance between well completions will be measured in hours as it is now in the Barnett as they move towards their 2010 goal of 60 rigs here.

    Marcellus Shale: Soon to "significantly increase drilling activity"
  • 1.6 million acres now
  • Completed 2 horizontal wells during the quarter which are producing at a combined rate of 7 MMcfepd. This is the first rate out of CHK I have seen on the Marcellus although they did say before these are 4 Bcfe type wells and they sound pleased with the results saying they plan to significantly increase drilling activity here in 2008 and 2009.

Check back later today for CHK's Q2 conference call transcript.