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Chesapeake Sees Costs Falling, Plans no Major Acquisitions

Oilfield services rates began to fall in the final three months of 2006, and there's "room for more price decreases through 2007," Chesapeake Energy Corp. CEO Aubrey McClendon said Friday. Chesapeake's goal is to cut service costs this year by as much as 10-15%, but the CEO said the price of natural gas will be the final determinant.

"It would be the first time since 2002 that costs have not increased year-over-year, if this prediction comes true," McClendon said. He and his management team spoke with financial analysts on a conference call Friday, and McClendon, well known for not necessarily following the rest of the independents, said he doesn't understand why other producers didn't see the higher service costs coming.

Chesapeake's total drilling and acquisition costs in 2006 were estimated at $1.93/Mcfe. Excluding revisions, Chesapeake's exploration and development costs through the drillbit were $2.00/Mcfe last year, and reserve replacement costs through acquisitions were $1.76/Mcfe.

"We started talking about cost trends going up two years ago, and in 2005 and 2006, we thought the costs would be the worst for years to come," McClendon said. "We had used up all of the service industry capacity then," and a lot of new rigs were ordered. "That build-out of rigs started to occur in late 2006, and now it will be hitting the market in 2007 and 2008."

The inflation has started to settle, and "I think it will be a very virtuous world for [exploration and production] E&P companies this year," he said. "The rig count can stay the same or go up, but unit costs for everything in the oilfield will continue to come down on a unit-cost basis."

Chesapeake, he said, is "very excited about the cost trends this year. We expect to see costs decline, and I think it's going to be a fabulous year for value creation."

It would difficult to argue with the McClendon's insights.

Chesapeake late Thursday reported that in the final three months of 2006, average daily oil and gas output jumped 17% to 1.653 Bcfe/d, compared with production of 1.417 Bcfe/d for the same period of 2005. For natural gas, production climbed to 138.8 Bcf/d, well ahead of 118.3 Bcf/d in 4Q2005. And it gained in gas output even though the company deferred 2 Bcf of production last October (see Daily GPI, Sept. 28, 2006).

Chesapeake began 2006 with estimated proved reserves of 7.521 Tcfe and ended the year 19% higher at 8.956 Tcfe. The company replaced 578 Bcfe of production with an estimated 2.013 Tcfe of new proved reserves for a reserve replacement rate of 348%.

"We're hoping to achieve at least 10% growth from our production and reserves this year," McClendon said Friday. "Our target for proved reserves at the end of 2007 is 10 Tcfe, and for the end of 2008, 11 Tcfe."

This year, Chesapeake will add value organically -- no major acquisitions are planned. A lot of companies may be vying for some of assets that Anadarko Petroleum Corp. has on the market, and others may be trying to snag Dominion Resources Inc.'s prized E&P assets (see Daily GPI, Jan. 25), but McClendon said Chesapeake will not be one of them.

"We've moved from the strategy that featured resource capture to one that favors resource conversion," he said. "You won't see Chesapeake's name beside either of those companies [Anadarko or Dominion]. I tell you what we said was true, we will be less active in acquisitions going forward. You will continue to hear rumors about us, and we're in all of the data rooms when things are for sale, but the market for acquisitions is more competitive than it's been in the last five years...The advent of private equity into the equation makes the likelihood of Chesapeake in the acquisition market probably quite low."

CFO Marc Rowland said Chesapeake has "so many opportunities for drilling and increasing the drill count; It still yields well over a 10-year inventory of things to do."

Added McClendon, "I said the big payout for shareholders was going to be in the resource conversion phase." He said he would "not be surprised if we don't do close to $750 million or even $1 billion worth of smaller, tactical acquisitions," what he called "tuck-in" acquisitions to enhance its position in one of its gas plays. "But I don't think the cards favor something really big."

Chesapeake's focus this year is "completely on converting the drilling side to proved developed reserves," he said. "We've communicated that now for six months, and that will continue to be our focus. We will continue to look at opportunities. We learn quite a bit when we evaluate things other people end up buying. Theoretically, there's always something out there that might be of value to us. At this point, I don't see anything on the horizon."

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