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Natural Gas Can Wait, Says Chesapeake CEO

In recognition of the "value gap" between oil and natural gas prices, Chesapeake Energy Corp. will continue to direct a big chunk of its technological and leasehold acquisition expertise to "identify, secure and commercialize" new unconventional liquids-rich plays, CEO Aubrey McClendon said Wednesday.

Speaking to financial analysts during a quarterly earnings conference call, McClendon noted that the Oklahoma City-based driller in the past two years has built a 4.1 million-net acre leasehold and ramped up production in multiple, domestic unconventional liquids-rich plays to accompany its gas-rich acreage. The oily acreage holds an estimated 5.2 billion boe (30.9 Tcfe) of risked unproved resources and 15.4 billion boe (92.4 Tcfe) of unrisked unproved resources.

The land gains, all in the Lower 48 states, will push oil and natural gas liquids (NGL) production to more than 150,000 boe/d, or 20-25% of total production, by year-end 2012 and to more than 250,000 boe/d, or 30-35% of total production, through organic growth by year-end 2015, the CEO said.

"The shift in strategy is more apparent day by day," he told analysts. However, there's no plan to shift Chesapeake expertise overseas.

"No international gas project can ever compete with an oil project in the U.S.," McClendon said. "That's why all of the international companies are here...why the world is coming to the U.S...We have unlocked the key to the most profitable oil projects in the world. Clearly, people are evidencing that by opening their checkbooks...which we are proud and pleased to be part of."

Chesapeake has become somewhat of an international chamber of commerce to global oil companies looking to nest in North American shale projects. Many of the business deals are through joint ventures (JV), with the Big Oil producer paying the drilling bill. However, the company is not averse to outright sales either.

By itself and with its partners Chesapeake's portfolio encompasses 13.27 million net acres nationwide. Gas shale leaseholds include 1.73 million net acres in the Marcellus, 530,000 net acres in the Haynesville, 205,000 net acres in the Bossier Sands, and 220,000 net acres in the Barnett. Liquids and oil shale acreage includes include 1.46 million net acres in the Anadarko Basin, 445,000 net acres in the Eagle Ford, 560,000 net acres in the Permian Basin, and 535,000 net acres in the Niobrara Shale (Powder River and Denver-Julesburg basins), as well as 1.05 million net acres in "other" plays now being tested.

On Monday Chesapeake clinched an agreement to sell its Fayetteville Shale properties for $4.75 billion in cash to BHP Billiton Petroleum, one of Australia's largest energy companies (see Shale Daily, Feb. 23). Earlier this month Chesapeake completed an agreement with CNOOC Ltd. to jointly explore 800,000 net acres in the Niobrara Shale (see Daily GPI, Feb. 3). Chesapeake already has a JV in place with the Chinese energy giant in the Eagle Ford Shale.

Still in place are Chesapeake's shale ventures with units that also are among the who's who of international explorers: BP plc, which has a one-quarter stake in the Fayetteville assets being sold to BHP; Statoil ASA, which partners in the Marcellus; Total SA, which has a 25% interest in the Barnett; and Plains Exploration and Production Co., its Haynesville partner.

"In the next five years Chesapeake's accelerated drilling will be increasingly directed to liquids-rich plays," said McClendon. The company's liquids output accounted for about 9% of total output in 2009. By 2010 total liquids production was around 11%. Liquids "will be 20% of total production in 2011," and by 2015, it is forecast to be "more than 30% of the production mix."

Based on the news reports in the Middle East and the macro environment, "oil prices should remain strong, maybe even scary strong, for years to come," he said. "Supply disruptions that may occur [in oil markets overseas] could be historic."

The turmoil -- and its solid U.S. shale portfolio -- puts Chesapeake in the sweet spot, the CEO said. Natural gas will remain the company's top dance partner, but for now oil and liquids drilling will be taking more spins on the dance floor.

Chesapeake produced 2.920 Bcfe/d in the final three months of 2010, up 12% from 2.618 Bcfe/d in the year-ago period. Average daily production consisted of 2.558 Bcf of natural gas and 60,457 bbl of oil and natural gas liquids (NGL). For the final period of 2010, the company's year/year growth rate of gas production was 5%; oil and NGLs production jumped 103%.

Around 88% of total production in 4Q2010 was gas-weighted, versus 93% in 4Q2009. Gas output in the final period totaled 235.3 Bcf from 224.5 Bcf a year earlier. Average realized gas prices in the latest quarter reached $5.22/Mcf, down from $6.05 in 4Q2009.

The shift to oil was obvious in the numbers: oil production soared quarter/quarter, jumping to 5,562 b/d from 2,737 b/d. Oil prices were down in 4Q2010 from a year earlier to $62.62/bbl from $71.61.

Last year the company drilled 1,445 gross operated wells (938 net wells with an average working interest of 65%) and participated in another 1,586 gross wells operated by other companies (211 net wells with an average working interest of 13%). The company's drilling success rate was 98% for both company-operated and nonoperated wells. Drilling and completion costs last year included the benefit of around $1.151 billion of drilling and completion carries from its JV partners.

On its total leasehold inventory, pro forma for the company's Fayetteville Shale sale and the Niobrara Shale JV with CNOOC, Chesapeake said it has identified an estimated:

Discounting the drilling program under way in the Fayetteville Shale, the company has 149 drilling rigs in operation to develop an inventory of around 37,800 net drill sites. Of Chesapeake's 149 operated rigs, 85 are drilling wells primarily focused on unconventional natural gas plays (including 50 operated rigs benefiting from drilling carries) and 61 are drilling wells primarily focused on unconventional liquids-rich plays (including 23 operated rigs benefiting from drilling carries) and three operated rigs are drilling in other plays. In addition, 143 of the company's 149 operated rigs are drilling horizontal wells.

Chesapeake reported net income of $180 million (28 cents/share) in 4Q2010, with operating cash flow of $1.186 billion. Excluding one-time items, adjusted net income was $478 million (70 cents/share). In 4Q2009 Chesapeake reported a net loss of $530 million (minus 84 cents), with operating cash flow of $1.2 billion.

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