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Chesapeake Curtails 7% of Output 'At Least' Through March

Chesapeake Energy Corp. last week curtailed 7%, or around 240 MMcfe/d, of its gross natural gas and oil production at least through March because of "extraordinarily" low wellhead prices in the Midcontinent region. Another 10% of the producer's drilling activity through the rest of this year may be slashed "if natural gas and oil prices remain low during the next few months."

The Oklahoma City-based driller said the 7% curtailment totals 200 MMcf/d of gross gas production and 6,000 b/d of gross oil production.

Through March "most Midcontinent natural gas prices at major interstate pipeline delivery points will average around $2.70/Mcf, a price at which most natural gas production is unprofitable," said CEO Aubrey McClendon. "We believe low wellhead prices combined with constrained capital availability will likely cause U.S. drilling activity to decline well beyond the 40% drop already seen since August 2008. As a result, U.S. natural gas production will begin to dramatically decline before the end of 2009 and consequently natural gas markets will regain better supply/demand balance by the end of 2009, if not sooner.

"Our attractive hedges, significant cash availability, approximately $4 billion of joint venture drilling carries and high asset quality provide Chesapeake with the strength to curtail a portion of our natural gas and oil production in low-price environments. In addition, we have reduced our drilling activity from 158 operated rigs in August 2008 to 110 currently."

If Chesapeake curtails more drilling activity, it would be in areas where it does not have joint venture (JV) carries, McClendon said. Chesapeake last year set up JVs with BP plc, StatoilHydro ASA and Plains Exploration & Production Co. (PXP) to help pay for some onshore exploration and drilling costs (see NGI, Nov. 17, 2008; Sept. 8, 2008; July 7, 2008).

Chesapeake also agreed to amend its JV agreement with PXP in the Haynesville Shale. PXP was granted a one-time option to avoid paying the last $800 million of PXP's $1.65 billion drilling carry obligation to Chesapeake, which represents 25% of the original JV transaction consideration.

The amendment includes three key features. First, the option only may be exercised by PXP from June 15, 2010 through June 30, 2010. If PXP elects to exercise the option, it would be required to convey 50% of all of its Haynesville Shale JV assets to Chesapeake as of Dec. 31, 2010, including all investments in leasehold, production and reserves at that date. PXP's investment in the Haynesville JV at the end of 2010 would range from $3 billion to $3.2 billion, Chesapeake estimated. Also, until the end of 2010, PXP's obligations both to pay for 50% of Chesapeake's drilling costs in the Haynesville Shale JV and to participate in each well in which Chesapeake participates "remain unchanged and are mandatory."

"We were open to accommodating our joint venture partner's request for a modification of the original agreement because of our great respect for PXP and our desire to be a supportive partner," said McClendon. "While we would be happy for PXP to exercise its one-time option in June 2010, we anticipate it will not do so since it would then have to forfeit 50% of its anticipated $3.0 billion to $3.2 billion investment in the premier U.S. shale play."

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