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Chesapeake Ups Ante in Marcellus; CEO Predicts 'Oil Shale Revolution'

November 5, 2010
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Chesapeake Energy Corp. CEO Aubrey McClendon continues to put his money where the shale is, most recently by adding another 500,000 net acres to the company's million-plus acre leasehold in the Marcellus Shale. 

McClendon, whose prowess in acquiring a position in the productive U.S. gas shales is second to none, also has begun to steer his company in an oily direction to be ready for what he predicts will be an "oil shale revolution." He offered his forecast before a packed audience on Wednesday at the World Shale Gas Conference & Exhibition in Grapevine, TX.

Chesapeake now is the No. 17 oil producer in the United States "and we expect to be in the top five in the next two or three years." Cashing in with early success in the shale gas basins of the country, McClendon now thinks shale oils are the way to go.

"We're on the verge of an unconventional oil revolution," the CEO predicted. "It is happening...Producers have begun to tap oil reserves in the domestic shale basins...Think about the enormous implications of that...We are about to experience a surge in oil production that will last at least 10 years...probably far beyond that."

If shale oil plays out like the shale gas has -- as McClendon expects -- the balance of power in the world would be forever altered.

"When you think about the implications, they are enormous," he said. When U.S. shale technology is successfully exported to other parts of the globe, including Europe, Asia, Africa and Latin America, many countries no longer would have to import their energy supplies. "Worldwide oil prices would be cheaper...there would be energy security...and the peak oil theory could be put off for a bit longer."

In looking at the "American experience, shales are changing the way we think about energy security, the environment...It's empowering other countries around the world that think they may no longer be limited in their choices to import oil and gas."

A big reason for Chesapeake's steer toward liquids play is simple: the price of natural gas just isn't that attractive, and it's not worth pursuing shale gas until prices reach the "magic number" of $6/Mcf, said McClendon. Until then, the company's booming gas production will be de-emphasized, and shale oil will be on the fast track.

The Oklahoma company took what it learned in the gas shales and applied it to oil shales beginning in 2009. The company year/year to date already has lifted its liquids-weighted profile to 10% of total output; Chesapeake had been about 98% weighted to gas at the end of last year.

"We retooled our factory to find oil rather than gas and make more money for shareholders...," said the CEO. So far, so good.

Chesapeake currently is using 140 operated gas and oil drilling rigs to develop a net inventory of about 40,000 drill sites. Ninety-five of the rigs are for gas plays, including 48 operated rigs using drilling carries. Forty-five rigs are drilling wells primarily focused on liquids plays. In addition, 133 of the rigs are drilling horizontal wells.

The gas rig count will be falling as contracts roll off over the coming months. First to drop will be rigs in the Haynesville Shale, which McClendon at one time had claimed was possibly the largest gas basin in North America.

Reducing rigs "does not reduce our commitment to gas, but the industry is generating far more supply..." Once gas achieves more parity with oil, "we will recommit ourselves to full-scale gas development."

Under joint venture (JV) partnerships structured with financially stout producers in the Marcellus, Fayetteville, Haynesville, Barnett and Eagle Ford shales, Chesapeake, once cash-strapped, is flush again. Those deep-pocketed partners also gave the company some breathing room as it began its quest for shale oil.

"Our view on partners is quite simply you can never have too many rich friends in this business," said McClendon.

 At the end of September Chesapeake gained $1.15 billion by selling some of its Barnett assets through its eighth volumetric production payment transaction, which included about 390 Bcf of proved reserves and 280 MMcf/d of average net production in 2011. Since launching the VPP transactions in late 2007, Chesapeake has sold about 1 Tcfe of proved reserves for a total of $4.7 billion, or about $4.70/Mcfe.

Chesapeake now is scouting for a JV partner to develop liquids-rich plays in Colorado's Powder River and Denver Jules basins, where it holds about 800,000 net acres. That partnership is expected to come together in the first three months of 2011, McClendon said.

Other deals continue to be made behind closed doors as well. Although McClendon didn't mention it publicly at the conference in Grapevine Wednesday, later that day in the quarterly earnings report the company said it acquired a "significant additional position in the Appalachian Basin from privately held Anschutz Corp.," a transaction about which NGI's Shale Daily reported in October (see Shale Daily, Oct. 8).

The $850 million transaction, scheduled to close later this month, includes 500,000 net acres and option rights. Chesapeake already plans to resell about 25% of the acquisition while the remainder would be combined with an estimable leasehold of more than one million net acres in the play. A new JV is anticipated in the first half of 2011.

"As with all of Chesapeake's leasehold acquisitions in new plays, the company's goal remains the same: acquire an industry-leading leasehold position in a new play and then bring in a minority industry partner to help de-risk the play and to provide reimbursement of all or most of Chesapeake's leasehold costs in the new play," said the CEO.

He told the World Shale audience, "You must be very quick in locking down positions. If you assume that the Barnett was the first gas shale successfully developed, and once industry broadly acknowledged that in 2005, within three years all of the major gas shales had been found.

"Likewise, we see the same time period playing out in oil shales and other oil formations as well. The Bakken [shale] serves the same role as the Barnett. Gas shales were generally accepted as economic in 2008. By 2011 the great land rush for best unconventional oil plays will be over as well. We intend to be leader in that part of the business."

Since the dawn of the North American shale age, which most put at around 2000 when George Mitchell began to shout about the Barnett, Chesapeake has built a 13.8 million net acre onshore inventory of gas and oil properties. and 27.4 million acres of 3-D seismic. The U.S. gas shale inventory includes about 2.8 million net acres, and Chesapeake also owns what may be the largest leasehold in two of the top three unconventional liquids plays: the Eagle Ford and Niobrara shales.

According to McClendon, Chesapeake's onshore properties hold an estimated 16.7 Tcfe of proved reserves (using volume estimates based on 10-year average New York Mercantile Exchange strip prices on Sept. 30), 102 Tcfe of risked unproved resources and 259 Tcfe of unrisked unproved resources.

Even if the company throttles back in the gas patch, look for the production numbers to keep rising.

According to the 3Q2010 report, Chesapeake expects to increase its oil and natural gas liquids production organically to more than 150,000 b/d, or 20-25% of total production, by year-end 2012 and to more than 250,000 b/d, or 25-30% of total production, through organic growth by year-end 2015.

And if gas prices reach McClendon's "magic number," watch out.

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