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Chesapeake CEO Says 'Not Time Yet' to Hedge

Since the beginning of this year Chesapeake Energy Corp. has delivered realized gas hedging gains of $1.8 billion, but it's in no rush to hedge any of its 2010 natural gas production, CEO Aubrey McClendon said last week.

"The reason is that in our view, it's simply not time yet," he told financial analysts during a conference call to discuss 3Q2009 earnings on Tuesday. "The art and science of hedging requires careful analysis and abundant patience, both of which we believe we possess in good measure...

"We have the capability to hedge almost four years of future national gas production. We will begin hedging some of that future production when the opportunities arrive to increase shareholder value through hedging rather than limit shareholder [value] creation through hedging, which we believe some in the industry have done recently."

Based on internal models and forecasts for U.S. gas supply and demand, "we think that leads us to the inescapable conclusion that gas production will be down significantly in the months and quarters ahead, and we think that will present us with ample opportunities" to hedge, he said.

Chesapeake has "been consistent for the past six months that we thought we would see [production] declines in the fourth quarter of 2009, but you are not going to see public confirmation of that until 2010," said McClendon.

His comments mirrored some made by EOG Resources Inc. CEO Mark Papa on Friday.

Chesapeake's modeling shows "a bottoming of gas production on a year-over-year basis in the late first quarter, early second quarter of 2010, and then declines will continue through 2010 to get an absolute trough of production sometime in the first half of 2011.

"So why is it taking longer for some of this stuff to show up?" McClendon asked. "I think it's the same as what we saw in Canada a few years ago. It just takes a long time for uncompleted wells to work through the system, and I think that's what's happening today...Obviously investors have been clued into this phenomena of wells that have not been hooked up and that the backlog hasn't cleared itself. We think it's cleared itself at our company and suspect that it has in the industry."

Chesapeake is "still trying to reconcile the numerous revisions that came out on the last round of EIA [Energy Information Administration] 914 data, and it's not entirely clear if it fully represents an accurate picture," said Investor Relations chief Jeff Mobley. "However, if you take what has been observed in the weekly storage reports, it's clear that the market has tightened over the past several weeks, and you saw a resurgence in demand through low fuel prices in September...The trend with a much lower rig count should lead to declines in production as we head into 2010, and we haven't seen any new data to discourage that yet."

A lot of work still needs to be done to ensure that policy leaders are aware of how much natural gas may be produceable in North America, McClendon said. The gas industry is "engaged across the board in a way that we never had before. We are communicating in ways that we never had before."

America's Natural Gas Alliance, which was formed earlier this year by some of the largest domestic producers, has "committed 1 cent/Mcf of production, which is, I guess, $80-90 million a year, and we will use that money to drive home our point of natural gas abundance," said the CEO. "Our problem isn't so much the coal industry...the credibility factor of that industry is pretty low...Our biggest challenges are just simply history.

"Remember this is an industry where we haven't been able to say our product is in abundance for most of the past 20 years, and today we can now say that. It takes a lot of people time to catch up to where we are from where we were four years ago."

McClendon admitted that "traditional" users of natural gas "are not helpful to us" because they are not convinced about how much gas could be produced.

"They do not want to see the market for natural gas develop, and we have our work cut out to convince those folks that there is plenty of natural gas for them and there's plenty of natural gas to begin to convert our transportation system away from oil to natural gas in a way to reduce our reliance on coal and the power sector. Those things take time."

Lower natural gas prices sent Chesapeake's profit down sharply in 3Q2009, the Oklahoma City-based producer reported. Net profit was $186 million (30 cents/share) in 2Q2009, compared with $3.29 billion ($5.62) in 3Q2008. Revenue fell to $1.81 billion, down from $7.49 billion in the year-ago period.

The company earlier this month said production in 3Q2009 climbed 7% from a year ago to 2.483 Bcfe/d and was up 1% sequentially from 2Q2009 (see NGI, Nov. 2). Chesapeake's current output now is close to 2.6 Bcfe/d, McClendon said.

The company's 3Q2009 results include a realized natural gas and oil hedging gain of $687 million. Excluding one-time items, Chesapeake generated adjusted net income of $440 million (70 cents/share). The excluded items included a hedging loss of $166 million and a combined after-tax charge of $88 million related to the spin-off of some midstream assets in a newly formed joint venture with Global Infrastructure Partners (see NGI, Sept. 28).

Average prices realized in 3Q2009 were $6.04/Mcf and $66.42/bbl. Excluding hedging activity, Chesapeake's average realized pricing basis differentials to the New York Mercantile Exchange in 3Q2009 were a negative 55 cents/Mcf and a negative $5.83/bbl.

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