Last year offered "ample reason" for investors to turn bearish on natural gas, Chesapeake Energy Corp. CEO Aubrey McClendon said Wednesday. "We heard it was a terrible product and no one would ever make any money at it."
The second largest gas driller in the United States responded, eschewing its bountiful domestic gas holdings to secure ground in the emerging oil and natural gas liquids (NGL) plays. As it had been doing for a few years, Chesapeake solidified joint ventures with deep pocket drillers and began selling off chunks of its gassy shales. Last year the business strategy then took a sharp turn to NGL production and today oil plays are a priority.
And why not? It's the sensible thing to do, the CEO told financial analysts during a conference call.
"We've seen the whole tone of investor calls and commentary change since the start of the year with regard to natural gas," McClendon said. "Today there is a lot of inbound traffic...from our investors, from analysts. People wonder if the worst is over. They have reasons to believe that it isn't, and we have our reasons to believe that it is."
Long one of the gas industry's most vocal cheerleaders, McClendon noted that once a producer makes the shift from gas to oil, "it's like an assembly line where you go from a $4 widget to a $15 widget... When the $4 widget becomes more expensive, there's still no reason to restart production.
"Why in the world would you shift back to $6 widget when you can make a $15 widget or a $16, $17 widget?" he asked. "At the end of the day [natural gas] is a terrific product...but today it sells at a terrible price. There's too big of an arbitrage between oil and natural gas. We're going to try and help them out...You can arbitrage about six different ways..."
Based on the turmoil now occurring in the Middle East, oil prices for the next several years will be "scary strong," he said.
Besides, U.S. drillers now have cracked the code with technological advances and can produce domestic shale oil almost as well as they can produce shale gas. It's a no-brainer.
"In the long term, once rigs move from gas to oil, gas that goes from $4 to $6 won't bring the rigs back. That won't happen here. That won't happen anywhere else," McClendon noted. Advanced technology "enabled Chesapeake to produce volumes of liquids [that were] unthinkable just two years ago."
A "bull case" exists long-term for North American natural gas. However, "an oil move is well under way, no matter what the gas market does."
Chesapeake late Monday announced that it would sell its Fayetteville Shale assets for $4.75 billion in cash to the petroleum unit of Australia's BHP Billiton Ltd. (see Daily GPI, Feb. 23). But slicing off the leasehold will make only a small dent in the Oklahoma City-based independent's gas reserves. It still would have an estimated 175 Tcf of unrisked gas resources in shales across the country, McClendon noted.
"Producers are responding to a return on their investment gap by drilling oil instead of gas wells," he said. "As rigs move away to oil plays where rigs are drilling for $15 a unit and they receive a more competitive rate of return, then the natural gas curve will have to increase...
"I find it curious that investors and analysts believe somehow that an increase in the gas price will somehow bring rigs back from oil projects where revenue levels are $15, $16, maybe $17 [a barrel]. That's the greatest misconception in the gas market today...A gain of $1-2 [in gas prices] won't cause the return of hundreds of rigs from more valuable oil plays. I assure you that it will simply not happen...without a significant rise in natural gas prices."
However, "natural gas is still important to us," the CEO said. He then proceeded to enumerate reasons why the domestic fuel will remain Chesapeake's favorite son.
"During the past two years natural gas already has achieved significant gains in generation at the expense of coal," he noted. The "social and political acceptance" of burning coal "will be more challenging in the years ahead...we estimate gas will pick up 1-1.5 Bcf during the remainder of the decade" for power generation.
The price tag of North American gas also is lower than anywhere else in the industrialized world and industrialized use, he said, should increase through the decade by 1 Bcf/d, relative to Europe and Asia.
McClendon, long an advocate for more compressed natural gas (CNG) vehicles, also reported seeing "increasing momentum...Congress has yet to understand the importance of CNG...We believe $4 and $5 gasoline and diesel may finally get their attention...The CNG market is moving ahead in virtually every corporation and vehicle fleet in the nation."
Another reason to be bullish: liquefied natural gas (LNG) exports, said the CEO.
"By year's end 2015, liquefied natural gas will be exported from the U.S. and from Canada. In North America this development will be notably aided by the widening of the Panama Canal, which will accommodate larger LNG vessels. This will affect the back of the natural gas curve by year's end 2012...Chesapeake is actively engaged in helping to advance several LNG export projects."
Commercial-scale gas-to-liquids projects also are moving forward and should be in operation by the end of 2016, noted McClendon. "When ground breaks near the end of 2013, it will have a bullish effect on U.S. natural gas markets...and Chesapeake is involved in this," he added.
"Finally, we believe drilling for natural gas will continue to decline for the remainder of this year and into 2012 as acreage becomes held by production, or HBP, especially in [the] Haynesville [shale]," he said. "The marginal cost of natural gas in the United States has been largely ignored as the industry races to hold acreage...as part of the land grab of 2008...As HBP ends, the land grab should stop."
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