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Michael Filloon
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Michael Filloon is the head energy analyst at Split Rock Private Trading and wealth management. He is an accomplished and well respected energy analyst covering cyclical sectors including Energy & Commodities. His focus are North American shale plays including the Bakken, Permian Basin and... More
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Split Rock Trading and Wealth Management
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The Bakken Update
  • Chesapeake (CHK):25/25 Plan 3 comments
    Feb 11, 2011 5:49 PM | about stocks: CHK, CEO
    Chesapeake Energy Corp. (NYSE:CHK) has made a major change to its business strategy.  What was once an aggressive driller of natural gas is getting oily.  The reason is easy to explain.  Tough to make a living in natural gas.  This is an aggressive move, but I bet the CEO can pull it off. 

    Chesapeake is currently the number two producer of natural gas in the United States.  The fourth quarter of last year Chesapeake's natural gas production was approximately 2.6 Bcf/d, with total company production of 2.9 bcfe/d.  It is the number one natural gas driller with respect to activity also. 

    Chesapeake has 154 operated, 115 non-operated ,and 15 info only rigs currently running.  This company collects over 20% of all daily drilling information generated in the United States.  Approximately half of 2011 capital is in liquids, while the other 50% is in natural gas.  Chesapeake says they will be able to shift production to 70% liquids in 2012.  It  has exhibited 21 consecutive years of sequential production growth and in 2010 year over year production growth was 14%.  This company is projecting a two year (2011 and 2012) production growth rate of 25%(net of asset sales).  Chesapeake estimates their liquids production to increase 2005, and their natural gas to grow 7%.  At the end of 2010, estimates of proved reserves were 16.9 tcfe.(*1) Unproven resource potential was 100 tcfe as recorded in 2010.  Unrisked unproven resource potential could be as high as 250 tcfe.  Chesapeake's leaseholds onshore are quite amazing at 13.6 mm net acres and 27mm net acres of 3-D seismic data. 

    In 2009, there was a big change with respect to oil and gas prices.  The "normal" 6 to 1 split has widened considerably with respect to lower natural gas prices. Chesapeake realized it's technology could be utilized in oil recovery and decided to change the scope of its business.  Due to its early acquisitions and correct as to the influx of natural gas production, they created shareholder value.  To cover their large debt they sold $5 billion in assets that had been purchased at a lower value.  Chesapeake is confident the change from 10% liquids in 2009 to approximately 70% liquids in 2012 will more than cover the sale of its natural gas properties.  It should also be noted these sales created a significantly higher value than what they were purchased for.  Chesapeake has since solidified assets in the Anadarko and Permian Basin.  The move to liquids increased positions in the Eagle Ford, Niobrara, and an undisclosed area (more than a million acres).  Chesapeake now has 100000 net acres in the Williston Basin. 

    Chesapeake's plan for 2011 and 2012 is to reduce long term debt by 25%.  They plan to increase production by 25%.  2011 estimated production is 3.13 bcfe/d.  2012 estimated production is 3.55 bcfe/d.  It also plans to deliver a 2011-2012 combined EBITDA of $10.8 billion, cash flow of $10.2 billion, and net income of 3.8 billion.(*2)  In 2010 they paid down senior notes by $1.4 billion.  That same year they also purchased $5 billion in liquids rich plays.  Since much of their oily purchases were completed at the beginning of the oil land grab, they were able to allow joint venture where the partner paid a significantly higher amount per acre.  As Chesapeake has done many times in the past, they continue to buy low and sell high.

    They have already increased liquids production from 32000 bbls/d in 2009, to 60000 bbls/d exit rate of 2010.  By the end of 2012, Chesapeake plans to have 150000 bbls/d and by the end of 2015 have and exit rate of 250000 bbls/d. 

    Bringing prominence to the Niobrara was the deal between Chesapeake (CHK), and CNOOC (NYSE:CEO).  This was a deal where Chesapeake sold 33.3% of its 800000 Niobrara acreage to CNOOC for $1.3 billion or $4750 per acre.   Up to this point, the acreage had sold for $3250 per acre, although Chesapeake had purchased their leasehold for less.   CNOOC will pay $570 million at closing and $700 million or two-thirds Chesapeake's drilling and completion expenditures, until the carry obligation has been funded.  This deal should close sometime this quarter.  Chesapeake expects to use the drilling carry by year end of 2014.  Chesapeake will remain the operator and CNOOC will have the option to purchase 33.3% of the new acreage and in the DJ and Powder River Basins.  This deal looks to be a good deal for both parties, but it raises questions as to whether Chesapeake is worried about upcoming liquidity, or if there are questions as to what the current acreage holds.  

    Chesapeake's oil land grab seems to have been a very good plan.  Shifting to liquids from gas provides an increase of $11/mcfe when comparing price equivalents.  This is why Chesapeake sees its EBITDA, cash flow and net income increasing substantially over the next four years.  This company believes its finding and production costs to be slightly higher, while unhedged revenues per unit should be approximately 3.5 times higher.  Even more important, is this company finding balance in its business.

    Chesapeake's large natural gas holding provides them, by 2015, to increase enough liquid production to be a top five producer, while still remaining a top two natural gas producer even after a $5 billion sale of natural gas assets.  250000 bbls/d is a lofty goal, for liquids production, but a compelling number none the less. Chesapeake's targeting of approximately 30 tcfe, which is 5.0 bboe by year end of 2015, shows very good growth with respect to the time frame involved.  
    With today's value metric the important numbers are the oily acreages they have attained, due to oil margins.  Chesapeake has attained acreages:
     
    Eagle Ford- 425000 net acres and 2.4 bboe of unrisked unproven resources
    Niobrara- 535000 net acres and 3,0 bboe of unrisked unproven resources
    Anadarko- 1 million net acres and 3.8 bboe of unrisked unproven resources
    Permian- 675000 net acres and 1.9 bboe or unrisked unproven resources
    Unknown- +1 million net acres, in what is called a liquids rich play

    Chesapeake states they will be cash flow positive, based on buying natural gas early and at a low price, then selling nonoperated positions off to JVs at higher levels.  It contends that they have done the same with respect to oil, and will be funded by joint ventures, like the one with CNOOC.  These JVs will essentially be funding $2.5 billion of operations on sales profits.  Chesapeake has a vast acreage in the United States.  This is 5.445 million acres with 60500 net unrisked undrilled wells, and 142 tcf of natural gas and 11 billion barrels of oil of potential net unrisked resource.  It is just a matter of time, until Chesapeake increases growth through the drill bit. 

    Chesapeake has a big move on its hands, some may be skeptical due to the scope of change.  In 2008, it was producing 13% oil and liquefied natural gas, and 87% natural gas.  In 2009, the number decreased to 10% oil.  2010 had a large increase to 32% oil and 68% gas.  This year's estimates are 50% liquids, and next year 70%.  Coupled with improvements in shale drilling (offset drilling, increased ceramic proppant, longer laterals, increased hydraulic horsepower and increased stages) rate of return should increase substantially.

    With respect to hedging, Chesapeake has shown a lucrative skill with respect to natural gas.  For 2011 they are 96% hedged in natural gas at $5.84.  In 2012 it is hedged 17% at $6.19. Since the first quarter of 2001, $6 billion in gains have been realized.  This hedging strategy has produced gains in 17 of past 19 quarters.    

    In summary, Chesapeake is working on its 25/25 plan, that should decrease long term debt by 25% while increasing production by 25%.  This company is in the process of converting from a natural gas company to one that is 75% liquids. Chesapeake has great leaseholds in some of the best play in the United States. There is no doubt that this is one of the best natural gas companies in the United States. The only question is how good they will be as a predominantly oil based company.  This company may be a very good investment long term,but I would not be exaggerating that it looks like the task at hand is difficult. .  If they pull it off, the pay out could be remarkable for investors.


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Additional disclosure: *1 Based on 12 month avg. price required by SEC rules.*2 Based on $85 oil and $5 gas
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Comments (3)
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  • kesavgupta
    , contributor
    Comments (4) | Send Message
     
    Based on the current JV's and divestitures implemented by Chesapeake, it might achieve "25/25" plan with full grace.
    Check this link:
    mergersandacquisitionr...
    7 Apr 2011, 08:46 AM Reply Like
  • Jason Merriam
    , contributor
    Comments (734) | Send Message
     
    Michael,
    CHK is certainly more approachable now than it was in late April. It looks like production costs came down in the March qtr., but more than offset by administrative costs (stock and compensation) and production taxes. JM
    4 May 2011, 08:21 PM Reply Like
  • Michael Filloon
    , contributor
    Comments (4027) | Send Message
     
    Author’s reply » I think that CHK will do what they did during the gas boom. They will probably do well with derivatives, and increase production much faster then expected. Most are still down on the company, but they have the equipment on know how to do well for some time.
    4 May 2011, 09:26 PM Reply Like
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