Chesapeake Energy CEO Aubrey McClendon has made no secret that he sees a market growth play for natural gas in growing concern over global warming and disaffection for "dirty" coal-fired power plants. And Friday he minced no words in promising that his company has the natural gas to fuel much of the power generation the country will need. If McClendon is right, Chesapeake could be the nation's No. 3 gas producer by year-end and No. 1 in as few as 18 months.

During the first quarter, Chesapeake's proved reserves increased 5% to 9.4 Tcfe. The company is on track to have its name on 10 Tcfe in the ground by the end of the year and 11 Tcfe by the end of 2008. "It should be clear that we should not have any trouble reaching these targets," McClendon said.

Further, Chesapeake's production growth momentum is "very strong," with production currently exceeding 1.8 Bcfe/d. "Any doubts about 14-18% production growth for 2007 would be misplaced," the CEO said. In just one year, McClendon pointed out, Chesapeake plans to grow production by 320 MMcfe/d.

"In just one year Chesapeake will add to production in our company an amount of production that is bigger than any of Southwestern [Energy], Cabot [Oil & Gas Corp.] or Range [Resources Corp.] or about the same size that Ultra [Petroleum Corp.] is today in terms of current production," McClendon said. "We believe that would be an un precedented achievement in our industry."

Another achievement is the fact that Chesapeake in the first quarter surpassed ExxonMobil to become the nation's sixth largest onshore gas producer, McClendon said. "During the first quarter our U.S. gas production increased by 3.7% over the 2006 fourth quarter gas production while Exxon's declined by exactly the mirror image of 3.7%.

Currently, Chesapeake is No. 6 in production behind ConocoPhillips, Anadarko Petroleum, BP, Chevron and Devon Energy.

"While not a specific goal of the company, we believe Chesapeake is on track to inevitably become the No. 1 gas producer in the U.S., probably by year-end 2008 or early 2009, a position, perhaps, that most might have thought improbable a few years ago."

In the first quarter average daily gas and oil production was 1,707 MMcfe, up from 1,519 MMcfe in the year-ago period. The company's production sold for $9.33/Mcfe, down from $9.60/Mcfe in the year-ago period, and expenses were up: 93 cents/Mcfe compared to 87 cents/Mcfe in the year-ago period. Production was 92% gas in the first quarter of this year and 91% gas in the year-ago period.

Natural gas production was 140.8 Bcf in the first quarter, up from 124.1 Bcf in the first quarter of 2006. The average realized natural gas price was $9.26/Mcf in the first quarter, down from $9.61 in the first quarter of 2006.

Net income for common shareholders was $232 million in the first quarter, down from $604 million a year ago. The 1Q2007 figure includes an unrealized after-tax mark-to-market loss of $193 million due to oil and gas interest rate hedging programs. Excluding this item, adjusted net income for common shareholders was $425 million in 1Q2007.

Revenues in the first quarter were $1.58 billion, down from $1.94 billion in the year-ago period, and costs were up: $1.09 billion in the first quarter compared to $993 million in the year-ago period. Items that saw an increase in the first quarter of 2007 were production expenses, general and administrative expenses, oil and gas marketing, service operations, oil and gas depreciation, depletion and amortization as well as depletion and amortization of other assets.

According to NGI's Top North American Gas Marketers for 4Q2006, Chesapeake ranked 21st with 1.50 Bcf/d in sales, up 27% from the 1.18 Bcf/d that the company marketed during 4Q2005. For the full ranking visit http://intelligencepress.com/features/rankings/gas/.

Chesapeake is driving its growth with the drillbit, McClendon told analysts during a Friday first quarter earnings conference call. The conventional Anadarko Basin accounts for the largest share of Chesapeake's production at 280 MMcf/d in 1Q. "Despite the view held by some that the Anadarko is fully developed, we believe otherwise," McClendon said.

However, the Barnett Shale play of East Texas is where much of Chesapeake's action is today and expected to be in the years ahead. The company is running 28 rigs currently and expects to have 36 by mid-summer. One year ago production out of the Barnett was 108 MMcf/d (net); now it's 200 MMcf/d (300 MMcf/d gross). With more rigs production will climb, McClendon said. By the end of the year net production should reach 300 MMcf/d (450 MMcf/d gross).

McClendon said the company can continue to grow production from the Barnett through 2010 as it plans to complete one well per day, every day for at least the next four years. Besides poking holes in the ground, Chesapeake is buying up acreage in the core Johnson and Tarrant counties. McClendon boasted the company is leading the way in urban acreage acquisitions around the Fort Worth-centered play.

Chesapeake has taken much of what it has learned in the Barnett Shale and applied it to efforts in the Fayetteville Shale, namely longer laterals. The company is ramping up to 12 rigs in the Fayetteville, and McClendon said Chesapeake should be able to complete a well there every other day.

In West Texas in the Delaware Basin Chesapeake is focusing on the Deep Haley area. Here, seven wells have been completed to date. Chesapeake is working with Anadarko Petroleum and McClendon said the Deep Haley will be a high-growth area for years to come.

McClendon said Chesapeake is the only company with positions in each of what he says are the three areas where it's still possible to drill "big gas wells" with production on the order of 15-50 MMcf/d. These are the deep Anadarko Basin in western Oklahoma, the deep Haley and the deep Bossier Play in East Texas.

In the Bossier Play Chesapeake just announced a $92 million deal to acquire all of Gastar Exploration Ltd.'s interests in a portion of Gastar's East Texas undeveloped leasehold. As part of the deal, Chesapeake is acquiring 10 million newly issued Gastar common shares for $2 each. McClendon said Chesapeake will have 350,000 potentially prospective acres in the Deep Bossier.

On the financial side of the house, CFO Marcus Rowland said Chesapeake has no plans to issue new equity at this time since the debt markets are "robust" and bankers have been lining up to pitch master limited partnership (MLP) deals targeting Chesapeake's midstream and compression assets. Additionally, there are "numerous" lease-back opportunities for the company's rig fleet. It wouldn't be hard to generate a cool $1 billion from deals potentially available, Rowland said.

Right now Chesapeake is pondering monetizing some of its proved developed producing reserves in Appalachia through an MLP, Rowland said. "We think this could be done for up to $1 billion, and the company would suffer almost no production loss on a percentage basis," he said. "And the proceeds could be reinvested into extremely high-rate equity drilling. The current MLP market has helped us value an asset we bought for $3 billion in November 2005 (see Daily GPI, Nov. 17, 2005) at perhaps as much as $5-7 billion."

What the MLP market could do for Chesapeake's Appalachian holdings, the looming market for carbon dioxide emissions could do for natural gas, at least if McClendon gets his wish. A carbon tax or cap-and-trade mechanism would eliminate the Btu premium that exists between natural gas and coal, he said, as natural gas is the "single best solution" for the need to generate more electricity and protect the environment.

"Our fuel has been cheap for too long, and I think we are in the process of an historical revaluation of our product," said McClendon, who is the founder of the recently announced American Clean Skies Foundation, which aims to promote gas-fired power generation (see Daily GPI, April 30).

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