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Chesapeake's Gas Output Up 18%, but Noncash Charges Sting

Chesapeake Energy Corp.'s natural gas-driven production jumped 18% last year, led by its "Big Four" gas shale plays: the Barnett, Haynesville, Fayetteville and Marcellus. However, with gas prices slumping from last year's highs, the producer last week launched a $1 billion long-term debt plan to bolster its financing.

The Oklahoma City-based producer had withdrawn its entire $3.5 billion line of credit when credit markets began to freeze up in October to ensure that it would have access to the cash. The bank debt is secured by the value of Chesapeake's gas reserves, which has fallen sharply along with the price of gas. Other producers, including onshore gas producer Petrohawk, also have issued long-term debt in the past few weeks. Chesapeake late Tuesday reported it would issue $500 million in long-term debt, but by midday Wednesday the offering had doubled.

The top U.S. gas producer by volume reported that its gas production -- all onshore -- jumped in 2008 to 2.3 Bcf/d. Chesapeake also increased its reserves by 11% to 12.1 Tcf. Production in 4Q2008 averaged 2.32 Bcfe, which was up 4% from 4Q2007 but flat sequentially from 3Q2008. Last year oil and natural gas liquids production averaged 30,956 boe/d.

Chesapeake's production gains came even though the company sold about 740 Bcfe of proved reserves and 240 MMcfe/d of production in various asset monetization transactions, noted CEO Aubrey K. McClendon. The company, he said, expects to deliver "further growth in 2009, as we continue to experience strong results in all of our 'Big Four' shale plays..."

However, there is a downside to the strong production and the turnaround in gas prices from a year ago. Chesapeake said it will record a $1.8 billion charge on its U.S.-based properties for 4Q2008. In addition, the gas producer modified its hedging position from December and will eliminate all 2009 "knockout" swaps. It could decrease or increase its hedging position, depending on how gas and oil futures markets change, the company noted.

Chesapeake "ended 2008 with approximately $1.75 billion in cash and cash equivalents on hand," said the CEO. "We will continue to carefully manage our corporate liquidity and capital spending levels to protect value and safely navigate the current challenging economic environment."

Energy analysts at SunTrust Robinson Humphrey/the Gerdes Group (STRH) Wednesday noted that Chesapeake's charges are noncash.

"Notably, the company had $1.75 billion in cash on hand at year-end '08, $500 million above our expectation," the STRH team said. Chesapeake's production also is going full steam, it noted. "In the Haynesville Shale, the company's last seven horizontal wells had average initial production/test rates of 16 MMcfe/d. The company anticipates running 25 rigs in the play this year. Notably, our '09 production expectation is at the high end of company guidance."

Motley Fool's Toby Shute said Chesapeake's charges were to be expected. Wednesday ConocoPhillips reported a $31.8 billion loss in the final three months of 2008 because of one-time charges to write down oil and gas properties that have lost value as prices have slumped (see related story).

More conservative exploration and production (E&P) operators like Apache Corp. and W&T Offshore also have been "talking about price-driven impairments to year-end proven reserve values," said Shute. "I concluded that if these conservative shops were facing writedowns, pretty much everyone else was likely to take a hit, too." Chesapeake's noncash impairment is "key," said Shute, because "cash flows are what matter here, not accounting earnings."

Chesapeake's debt offering, said Shute, is "exactly the same thing" that Petrohawk has done, "with exactly the same stated purpose. You could surmise that these firms are afraid of having their borrowing bases reduced by leery lenders, but it's just as likely that the E&Ps are concerned about dealing with banks that could spontaneously combust. By issuing senior notes in order to pay down a revolver, Chesapeake isn't increasing its net debt. This is a shift to a more stable funding source."

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