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North American Gas Output 'Headed South' by 2010, Says Chesapeake CEO

May 11, 2009
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If the U.S. natural gas rig count this year remains at around 700 and Canada has about 50 gas rigs running, North American gas production by early 2010 "will be 10% lower and headed south pretty quickly," Chesapeake Energy Corp. CEO Aubrey McClendon said last Tuesday.

McClendon, who presided over a conference call last week to discuss the company's performance in 1Q2009, said North America "needs to have some rebound in gas prices...not a whole lot, to $6-7/Mcf, compared with the normalized price range. What is the case for higher prices from here? The first thing to observe is the most obvious. Today's gas prices are not high enough to support the rig count..." And that will lead to a big rebound in prices late this year or in 1Q2010, he said.

"Once we figure out what LNG [liquefied natural gas] imports will look like by this summer, investors will begin to look at the inescapable reality that by this winter gas supplies will likely be in a free fall," McClendon said. "You'll have to consider how many gas market investors will want to be in a short position in that scenario. My view is, not many. There will be a dramatic rebound by this fall or this winter...In the gas markets, we've come to expect the unexpected in the last few years. If oil goes to $60/bbl, I wouldn't be surprised to see a rise in gas futures earlier than most are predicting...

"How high will gas prices go? I don't know...Clearly they were too high at $13/Mcf last summer, and now they are too low. The rebound probably will overshoot the high side and producers will have to be heeled financially for quite some time to have the capital to stabilize gas production..."

Based on Chesapeake's internal forecasting, unconventional gas plays -- in which it specializes -- need $6-7/Mcf New York Mercantile Exchange prices. "The more challenged, conventional gas plays need $8-9 for drilling to return to sufficient levels," said McClendon. "You have to have a gas price able to perform maintenance-level drilling. A long-term floor of $8/Mcf is needed to grow North American gas production. And that means a gas rig count that is 50% higher than where we are today."

At today's gas price levels, it was the "absolutely correct decision to curtail drilling" in most of Chesapeake's leaseholds, said the CEO. The company is laying down rigs in the Midcontinent, Permian Basin and South Texas, and is moving some of those rigs to the Haynesville and Marcellus shale plays. "We have 400 MMcf/d curtailed now, and it has made absolute sense to curtail completion of wells or production at the price environment we're in."

Around 400 of Chesapeake's wells have yet to be completed. But McClendon said the number voluntarily curtailed is actually only around 100. The other 300 wells are awaiting third-party infrastructure, he said.

Chesapeake is operating 96 rigs across its U.S. properties, which is down from 112 at this time last year. Eighty-eight rigs are operating in Chesapeake's unconventional plays, with 76 running in its "Big Four" shale plays: Haynesville, Marcellus, Barnett and Fayetteville.

Despite asset sales, volumetric production payment agreements and production curtailments, Chesapeake's output grew 3% from the same period a year ago, McClendon noted.

Chesapeake's average production for 1Q2009 consisted of 2.175 Bcf/d of gas and 31,933 b/d of oil and natural gas liquids (NGL). The company's 1Q2009 output of 213 Bcfe was composed of 195.7 Bcf (92% on a natural gas equivalent basis) and 2.9 million bbl of oil and NGL (8% on a natural gas equivalent basis).

Hammered by the slump in the value of its onshore gas-weighted property, Chesapeake reported more than $6.11 billion in one-time charges in 1Q2009. Under fire from some shareholders for paying McClendon $112.5 million in compensation last year even as its stock price plunged, Chesapeake reported a net loss of $5.75 billion (minus $9.63/share). Chesapeake in 1Q2008 reported a loss of $142 million (minus 29 cents).

The latest results included a $519 million hedging gain and $91 million in mark-to-market gains. Excluding one-time items, Chesapeake's 1Q2008 earnings fell to 46 cents/share from $1.09 a year ago. In the first three months of 2009 Chesapeake's revenue jumped 24% to $2 billion.

Through 2009 the Oklahoma City-based producer has trimmed its capital expenditures by $500 million, or around 8%, to $6 billion. The company also plans to sell some assets this year to reduce its debt. According to Chesapeake, a private equity investor is interested in buying a 50% minority stake in the company's Barnett Shale and Midcontinent gas gathering and processing assets. If the sale is completed as expected later this year, Chesapeake expects to net around $550 million from the sale. Chesapeake said it also is talking with several companies about another joint venture in the Barnett Shale, which would result in proceeds of $200-300 million. That deal could close by the end of this year.

McClendon came out swinging early in the conference call to address the hoopla over his compensation package, which was first detailed in a Securities and Exchange Commission (SEC) Form 8-K filing earlier this year (see NGI, Jan. 12). McClendon's revised five-year employment contract awarded him a $975,000/year salary, and last year gave him a one-time $75 million retention bonus for the leadership role he played in negotiating four joint ventures in the Haynesville, Woodford, Fayetteville and Marcellus shales.

The CEO said it was only in the past few weeks that some of the company's shareholders voiced their disappointment in the compensation package (see NGI, May 4). However, he apologized for the distraction and said he'd answer any questions or concerns. During the call, which lasted more than an hour, not one analyst raised the issue.

Tudor, Pickering, Holt & Co. Securities Inc. (TPH) analysts noted that there were "too many moving pieces" in 1Q2009, and combined with the recent "big outperformance and exec compensation brouhaha, this stock is slipping down the gassy pecking order for many investors."

Meanwhile, said the TPH team, the company "has done a solid job improving/recovering/repairing investor confidence in the quality of the assets and improving the balance sheet via joint ventures, asset sales and capital expenditure cuts...

"Given all the drama around the stock in the past six-nine months, we've argued that nothing argues more strongly than results" as Chesapeake "continues to deliver them, the stock will react accordingly."

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