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Chesapeake: Slow Drilling Recovery, More Global Interest in Shales

February 23, 2009
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Even if the natural gas price "signals to drill again," producers will be slow to do so, Chesapeake Energy Corp. CEO Aubrey McClendon said Wednesday. The extra cash from higher prices for as long as the next two years is more likely to "go to fill up the buckets again before people get aggressive with the drillbit," he said.

McClendon offered his perspective on the gas markets during a wide-ranging quarterly earnings conference call with energy analysts, during which the company reported 4Q2008 net losses of $866 million (minus $1.51/share) versus a profit of $158 million (33 cents) for the same period a year ago.

Results were impacted by a $1.73 billion noncash writedown of natural gas reserves for year-end commodity prices. Excluding the writedowns, Chesapeake earned $427 million (73 cents/share) in the final quarter of 2008. The Oklahoma City-based producer reported revenue in 4Q2008 rose to $2.98 billion from $2.1 billion a year ago.

"Like in other declines, and like the rig decline we are going through," McClendon said, "the declines come fast and hard, the recovery comes slow...The industry is capable of producing as much gas as the country requires. If our country makes policy choices that favor gas over coal for electricity generation, or if we more aggressively move transportation to natural gas, the industry can respond very quickly if given the price signals to do so."

The U.S. onshore rig count has dipped considerably since late last year, with exploration and production companies laying down rigs in reaction to falling gas prices and an oversupply. However, McClendon said another factor likely is at work -- and that may determine how long it takes to see a renewed vigor in the oil patch.

"Everyone is looking for some historical precedent on the rig count, but in my 25 years in the business, this is the first time when there's been a bad environment for gas prices and an enormous inability to obtain credit," said the CEO. "I think this will drive the rig count down further, more than people thought. The credit market might even be a...larger factor in driving the rig count down than gas prices. I think we'll see an accelerated rig count decline, and it will continue for at least the next couple of months."

Chesapeake has dropped its onshore rig count from last year's high of around 158 to 115 or so now, he said. Another 10 rigs or so will be cut before the company gets to a comfortable level of 105-106 rigs, said the CEO.

However, there is a silver lining, said McClendon.

"The seeds of a gas recovery have been sown, and they are being well watered as we speak," he told the analysts. "Low gas prices are actually good for Chesapeake. We have more than $4 billion of our drilling costs paid for in the next four years" through joint venture partnerships with BP plc and StatoilHydro ASA, among others, "and a low gas price environment means drilling costs are lower...

"We think drilling costs will decline in 2009 by as much as 25%," and with the bulk of drilling already paid for, McClendon said Chesapeake could drill more wells at less cost than competitors. "We think we will be more able to ride out the low gas price environment with less pain..."

The U.S. gas rig count "is likely to bottom out in the first half of 2009, back down to as much as a five-year low," McClendon said. And by the end of this year he thinks "gas production will be in full retreat," which sets up a positive scenario for producers. "No matter how bad the economy gets, gas demand cannot fall faster than the 25% depletion rate."

Chesapeake is basing its outlook on an average 2009 New York Mercantile Exchange (Nymex) gas price of $6-7/MMBtu. McClendon admitted that prices could fall more.

"We're optimists...but the whole industry is hemorrhaging cash right now. Industries like this can hemorrhage for a while, but it can't hemorrhage for very long before depletion takes over," he said.

A $6-7 Nymex gas price "will be uneconomic for most gas drilling in the United States," said the CEO. "That's not a particularly heroic gas price. If we're wrong and prices don't cooperate, and we don't see the rig count go down as much as we hope for, we're still in good shape. Even at $5 gas prices, our operating cash flow for 2009 is only $110 million lower than gas at $7...

"It doesn't really matter how low gas prices go," said McClendon. With most of the company's big drilling plans paid for, "it sets us up for a rebound, and it differentiates our strategy..."

Chesapeake last year set up separate joint ventures with BP, StatoilHydro and Plains Exploration & Production Co. to help pay for some of its exploration and drilling costs (see NGI, Nov. 17, 2008; Sept. 8, 2008; July 7, 2008). Now the company wants a partner to help with costs in the Barnett Shale, and international energy companies are knocking at the door, said McClendon.

"We have multiple ongoing conversations with international energy producers," he said during the conference call. "Some of them involve the Barnett, some involve other plays...

"In general, there is a high degree of international energy company interest in gas shales in the U.S. If you are one of those companies, as you survey the U.S. gas scene, and you look at the companies with the largest asset base in shale plays, companies that have done business with international energy companies...most, if not all, of the roads lead to Chesapeake."

The big players aren't interested in mergers, necessarily, he said.

"Everybody is always talking about consolidation, but I think it's more likely that two things will occur in 2009," McClendon said. "One is the widening gap between the 'haves' and the 'have nots,'" with the "haves" being companies that have a leasehold in one of the "Big Four" shale plays: Haynesville, Barnett, Fayetteville and Marcellus; and "the arrival of some new international energy players in the North American gas market. I doubt, frankly, they'll do it through M&A [mergers and acquisitions], but more through a JV [joint venture] concept...Hopefully, they'll do it with us."

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