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Chesapeake CEO: Rig Count to 'Melt Away' through 2009

With natural gas prices still low and budget cutbacks across the energy sector, 300-500 rigs likely will be taken out of service in the coming year, Chesapeake Energy Corp. CEO Aubrey McClendon reaffirmed Friday. However, the CEO sees a silver lining to the current turmoil and said his company will prepare for better days ahead.

McClendon shared his concerns about the marketplace and the gas industry's prospects during a conference call Friday in which he and his management team discussed the company's 3Q2008 earnings. There's no doubt, McClendon said, that the gas rig count has fallen and will continue to "melt away pretty quickly" in the coming months.

Despite the "most unusual" quarter he'd ever seen, "better days lie ahead for all of us," McClendon told analysts. "I'm upbeat about gas prices in the next nine months and beyond." He is even upbeat about the possible outcome from Tuesday's presidential election. "I believe gas will be treated very favorably in an Obama administration, if he's elected. There are other macro trends out there that also will help gas prices in the years ahead."

For now, though, the gas industry has to hunker down, McClendon said.

"Like everybody in the industry, I've been thinking a lot about the capital spending [capex] reductions," which have been announced at Chesapeake and many oil and gas companies in the past few weeks. McClendon first suggested there would be high rig cutbacks in September, and in response, Chesapeake trimmed its capex by $4 billion through 2010 (see NGI, Sept. 29). Around 100 MMcf/d already has been shut in, mostly in Oklahoma, he said.

"Our rig count hit a high water mark this year at 150, and it's now around 145, and we'll have a low of about 128 by the end of the year," he said. "We do have contingency plans to take it further down if we need to. We will not outspend our cash resources in 2009 or 2010.

"The exact number of rigs that goes away is anybody's guess, but I think it will be at least 300, and as many as 400 and 500 on the way down. I thought, going into 2009 we wouldn't achieve those levels, but the credit crunch is playing a bigger role than low gas prices..." and it's fallen faster than expected.

Predicting how low the gas rig count may go depends on a lot of factors, he said. "Often times, companies have multi-well commitments, which makes it a little stickier...and maybe that's why we haven't seen it drop off as quickly as people might have thought."

There likely will be "much healthier supply imbalances, certainly by the summer of 2009, and I can almost guarantee it will be better in 2010 than I would have guessed a few months ago," he said. "It's only a matter of time before supply growth kicks back in and prices rise in response. Deferred demand growth is easier to restore than deferred supply growth. No matter how high oil prices rise, we'll always have clean, affordable American natural gas to save the day."

Chesapeake already has begun to see lower service and operating costs. For instance, leases that producers have been attempting to acquire in the Barnett and Haynesville shales have dropped from highs that just a few months ago were in the $20,000-30,000/acre range to a current price of around $5,000, said the CEO.

"We've seen a dramatic reduction in leasehold costs -- not value -- in the Haynesville and in the Barnett. The value remains very attractive to us. In the Barnett we led the way by saying that gas prices in this environment no longer made sense to pay more than $5,000 per net acre there, and the rest of the industry has followed suit."

Overall, Chesapeake could see "as much as a 15-20% reduction" in its costs. "Diesel prices are down, and we consume a lot. Steel prices have rolled over, and we've seen the worst of that...Drilling rates are starting to come down, and we see that accelerating. It will be costs across the industry and across all of the components of well costs...These things go up and down, and as our margins are squeezed, it's only fair of course that our partners on the service side lower their prices. It will enable us to make a profit on what we're doing, and we expect to see very visible responses to those initiatives in the next couple of quarters."

For the quarter, Chesapeake reported net income of $3.282 billion ($5.61/share) and operating cash flow of $1.4 billion on revenue of $7.491 billion. Excluding a one-time hedging gain of $2.85 billion, Chesapeake's adjusted net profit in 3Q2008 was $485 million (85 cents/share). In 3Q2007 Chesapeake's net income reached $346 million (72 cents/share) on revenue of $2.03 billion. Adjusted net income in 3Q2007 was $330 million (69 cents/share).

Production, which is 92% weighted to gas, in 3Q2008 reached 2.3 Bcfe/d, which was 15% more than in the same period a year ago. Proved reserves totaled 12.1 Tcfe in the quarter, which is 11% more year-to-date on 1.2 Tcfe of net additions.

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