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Chesapeake CEO Credits Midcontinent Focus for Strong Gas Output

By zeroing in on Midcontinent natural gas wells, Chesapeake Energy Corp. has now moved into position as one of the largest customers of U.S. onshore drilling service companies, which has given it substantial negotiating power, CEO Aubrey McClendon said last week.

Speaking at the Howard Weil Energy Conference in New Orleans, McClendon said most exploration and production companies working in North America are "too diversified" and "too spread out," resulting in "operational mediocrity. There's no coherent corporate strategy."

Instead, Chesapeake has centered its efforts to be "better at one thing than everyone else...for us, that's the Midcontinent," which spans Oklahoma, North Texas, the Texas Panhandle, Kansas and western Arkansas.

"Scale wins power," he told the audience. With scale, Chesapeake "demands and receives the best prices and best services from the service industry." The company also is able to generate more than 50% of all the drilling information in the Midcontinent, giving it a "tremendous competitive advantage."

The Midcontinent is the third largest natural gas basin in the United States, and the top three producers operating there -- Chesapeake (19%), BP (8%) and Apache Corp. (5%) -- "produce 32% of the gas," he said. The "other 247" with operations in the region produce 58% of the gas, and "5,000-plus others" produce the last 10%.

"The Midcontinent has been 'short' gas and 'long' infrastructure," said the CEO, which "leads to strong wellhead prices and low service and midstream costs." That, in turn, "results in higher profitability per unit of production."

Other independents may be searching for more rigs to drill, but Chesapeake took the matter into its own hands. The company is now building the Nomac Drilling Unit, and it also has a 17% stake in Pioneer Drilling Co. Nomac has 11 rigs operating and is in the process of increasing its rig operation to 22. Pioneer now operates 55 rigs. Chesapeake's expects its two investments will generate a combined $200 million in profit.

Slowly, Chesapeake also is increasing its secondary exploration focus in Texas, which includes the Permian Basin, the Gulf Coast and Barnett Shale, where geological characteristics are similar to the Midcontinent. The secondary areas are relatively free of regulatory or access issues, and they also are ready for regional consolidation because of a pullout by major producers, he said.

"Acquisition prices haven't moved up as much as gas prices, so acquisition opportunities are as good as they have ever been," McClendon said. Margins for acquisitions reached $4.77/Mcfe in 2004 from $1.31/Mcfe in 1998 when Chesapeake began to acquire properties.

Chesapeake has added 800 MMcf/d from its acquisitions since early 2001, but 57% of the growth has come from drilling, McClendon said. Organically, production has grown 13% a year over the past four years and 32% a year when acquisitions are included.

McClendon said independents aren't drilling enough gas wells in the United States. Even though the majors, including BP and ExxonMobil Corp., continue to surpass the independents with domestic production, the independents are drilling more, he noted. Chesapeake increased the number of rigs it had running to 69 in March from 37 at the end of 2003.

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