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Chesapeake Curtails Gas, Targets Utica, Eagle Ford

Chesapeake Energy Corp., the second largest natural gas producer in the United States, has shut in 1 Bcf/d gross through October, CEO Aubrey McClendon told investors on Wednesday.

The curtailments are double the amount that the company shut in during January (see Shale Daily, Jan. 24). Chesapeake also plans to defer completions for dry gas wells that have been drilled and it has deferred dry gas pipeline connections. Most of the curtailed gas output is in the Haynesville and Barnett shales.

McClendon and his management team spoke with analysts during a conference call to discuss quarterly and year-end earnings.

Until gas prices strengthen, which the CEO thinks could be as soon as 2013, the focus will be on liquids and oil.

Average production in 4Q2011 totaled 3,596 MMcfe/d, up from 2,910 MMcfe in 4Q2010 and ahead of 3,329 MMcfe in 3Q2011. For the year output rose to 3,272 MMcfe from 2,836 MMcfe in 2010. Liquids comprised 18% of Chesapeake's output in the final three months of 2011, just 1% more than in 3Q2011, but up from 12% in the year-ago quarter. Natural gas production, which comprised 82% of total output in 4Q2011, totaled 272 Bcf in the final quarter, versus 235 Bcf in 4Q2010 and 254 Bcf in 3Q2011.

Chesapeake's dry gas rig count is to be cut before mid-year from an average of about 75 dry gas rigs used during 2011 to 24 rigs, "including 12 rigs in the northeastern portion of the Marcellus Shale, six rigs in the Haynesville Shale and six rigs in the Barnett Shale," McClendon said. "Chesapeake's operated dry gas drilling capital expenditures in 2012, net of drilling carries, are expected to decrease to $900 million, a decrease of approximately 70% from similar expenditures of $3.1 billion in 2011 and the company's lowest expenditures on dry gas plays since 2005."

In the final three months of 2011 the company's oil and natural gas liquids output was about 104,000 b/d. Next year output should reach 203,000-214,000 b/d, and by 2015 oil and liquids output is forecast to jump to 250,000 b/d.

Chesapeake last year produced almost 1.2 Tcfe net and increased gross operated production to 6.4 Bcfe/d. Even though it sold 2.8 Tcfe of proved reserves, the company still had 18.8 Tcfe at year's end. Close to 5.6 Tcfe of proved reserves were added in 2011 at a drilling and completion cost of $1.08/Mcf. The company drilled 1,680 gross wells and connected more than 1,400. It also participated in 1,250 wells and its partners turned 1,050 of them.

"On the oil side, we hope to have some breakthroughs this year," McClendon said.

The big drilling targets this year will be the Utica and Eagle Ford shales. The company to date has brought 42 wells online in the Utica, where it has six rigs working in the wet gas window, one in dry gas and one in oil.

"We'll be ramping up to 20 rigs by year-end 2012," COO Steve Dixon said of the Utica. To date Chesapeake has drilled 42 wells in the northeastern play; it now has seven producing and 35 waiting on completion and pipeline connection. Two recent completions (Burgett and Shaw) produced average peak rates of more than 700 b/d and 3.0 MMcf/d. About 200 miles of pipelines are to be installed in the play this year.

"We're already starting to see drilling efficiencies in the play," Dixon said. Chesapeake's spud-to-rig-release now is around 16 days.

Of the 161 operated rigs now drilling, 90% are in liquids-rich plays. That number should remain "relatively level" for this year, said Dixon, with 33 rigs in the Eagle Ford Shale; 22 in the Mississippi Lime formation; 20 in Cleveland and Tonkawa plays; 14 in the Utica; 13 in the Granite Wash; and 10 in the Permian Basin. The company last month said it plans to sell outright or complete a JV in the Permian this year.

Exploratory drilling in the Williston Basin, which includes the Bakken Shale and Niobrara formation, so far has been less than expected, McClendon told analysts. Rigs now are being shifted to the western edge of the acreage to continue exploration.

"We're disappointed to date in what we've seen with the Bakken. I suspect the western part of our acreage will probably work out fine."

As the producer began to transition to more liquids plays two years ago, it began to make more big investments, a move questioned by many energy analysts and investors. In response, McClendon spent a few minutes criticizing his critics.

"The shift away from gas to oil required us to outspend cash flow," said McClendon. "That has caused anxiety from observers," but the company will "easily fund the gap with proceeds from sales this year, combined with operating cash flow. By 2014 I am confident Chesapeake will have reached the breakeven between operating cash flow and capital sending, even if natural gas prices remain at low levels, which, given the rapidly changing supply and demand fundamentals emerging in real time before us today, is very unlikely..."

At the end of the day, he said, "outputs matter, not inputs. We are increasing in size and value on a per-unit basis, an achievement that is quite remarkable, that will put us in a position in three years, in 2014, where we are cash flow positive. By 2015 cash flow should be $10-11 billion and we should be several multiples higher."

If "inputs where the only thing that mattered, we'd live within our cash flow and sit here and wait for higher gas prices." Instead the company has continued to acquire more leasehold and is "delevering the company by 25%...We've done this in an environment of sub-$3.00 gas prices..."Analysts "are skeptical of our ability to achieve," McClendon claimed. "Their skepticism will not be rewarded at the end of the day. Our shareholders will be rewarded."

This year, however, the company is marching through 2012 with a two-pronged attack: increase oil and liquids output, and decrease financial leverage. Operating cash flow in 2012 is estimated to be around $5 billion, with more than half of the revenue (60%) to come from oil and gas liquids. The company plans to increase operating cash flow by almost 60% in 2013 from this year, "assuming only a $1.00 increase in gas prices," McClendon said.

Of the 161 operated rigs now drilling, 90% are in liquids-rich plays. That number should remain "relatively level" for this year, said Dixon, with 33 rigs in the Eagle Ford Shale; 22 in the Mississippi Lime formation; 20 in Cleveland and Tonkawa plays; 14 in the Utica; 13 in the Granite Wash; and 10 in the Permian Basin. The company last month said it plans to sell outright or complete a JV in the Permian this year.

Net income totaled $429 million (63 cents/share) in 4Q2011, with operating cash flow of $1.3 billion and revenue of $2.73 billion. Production totaled 331 Bcfe. In 2011 Chesapeake earned $1.57 billion ($2.32/share) with operating cash flow of $5.31 billion and revenue of $11.64 billion. Production for the year reached more than 1.19 Tcfe.

Chesapeake's average daily production of 3.596 Bcfe in 4Q2011 consisted of about 2.959 Bcf of gas and 106,000 bbl of oil and natural gas liquids. Proved natural gas and oil reserves in 2011 increased by 1.7 Tcfe, or 10% year/year to 18.8 Tcfe, despite the sale of 2.8 Tcfe. As a result of production curtailments and reduced drilling and completion activity, partially offset by growth in associated natural gas production in liquids-rich plays, Chesapeake said 2012 net gas production will average about 2.65 Bcf/d, down 100 MMcf/d, or 4%, from 2011 average output of 2.75 Bcf/d.

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