In the next few months 200-400 rigs could be “laid down” in response to low natural gas prices, Chesapeake Energy Corp. CEO Aubrey McClendon said Tuesday.
Speaking with energy analysts about his company’s decision to reduce capital spending (capex) through 2010 because gas prices have slumped 50% since June, McClendon said more gas-intensive independents are sure to follow. Chesapeake is the largest gas driller in the United States.
“While we may be the first, we will certainly not be the last,” McClendon said during the hour-long conference call. “In the business today, producers have made decisions based on $10-13/Mcf and they are running gas rigs. In the world we have seen in the last 60 days, we don’t think there’s enough cash flow there to support that kind of drilling activity.”
Chesapeake announced late Monday that it will reduce its capex budget by 17%, or $3.2 billion, because of the drop in gas prices (see Daily GPI, Sept. 23a). Chesapeake adjusted its projected growth rate this year to 18% from 21%, and it now expects to achieve a 16% growth rate through 2010, which is about 5% below earlier forecasts. “This will help demand growth to catch up to supply growth,” the CEO said.
Chesapeake based its capex through 2010 on gas averaging $8/Mcf, which translates to $6.50 at the wellhead on a national basis, said McClendon. For some operators, drilling wells at $6.50/Mcf would be a “tough price” to maintain, he said.
“In regard to the rest of the industry, there are only about 10 companies that probably matter in shale plays; you really can distill no more than half a dozen,” he said. “These $10-13 gas prices that supported a lot of drilling in marginal areas will probably go away first, but the rig counts in the shale plays will continue to ramp up over time.”
Chesapeake is unlikely to stifle its drilling plans in the emerging Haynesville Shale or in Arkansas’ Fayetteville Shale. However, Chesapeake’s production in the Barnett Shale of Texas has peaked, said the CEO.
“In general, drilling will begin to ramp down in the Barnett, to be offset by growth in the Haynesville,” he said. “On a net-net basis, we hope we are always laying down the most marginal rigs. The impact here on gas supply and demand balance going forward is we’ll see more than a 25-50 rig cut [across the industry]. We need several hundred rigs to be cut to have an impact.”
McClendon is “pretty comfortable…that demand will continue to grow over time. We need to accelerate that demand, and we’re doing everything we can to do that. It’s frustrating to have a product that is so clearly superior to foreign oil…and the country has been a little bit slow to recognize that…” Within a few years gas demand will accelerate, he said, because “we are clearly headed toward a time of some kind of carbon constraint, and that will hurt coal and help natural gas.”
In the meantime, “there are moves afoot to see if there are export markets or export avenues in North America for natural gas to be transported via LNG [liquefied natural gas] because global markets are generally two to two-and-a-half times better than American prices,” McClendon said. “Industry has cracked the code on how to increase supply very quickly. It’s proven easier to ramp up supply than for the rest of the country to ramp up demand, and I expect in time for that to get back in balance.”
Chesapeake has been exploring a way to export its gas for about two months, McClendon said. He first spoke of about finding avenues to export Chesapeake’s gas in late July (see Daily GPI, Aug. 4).
“We’re pretty deeply enmeshed with global LNG players, and we’ve hired Citibank to help us with these conversations,” he told analysts. “We’ve learned a lot. Looking at U.S. gas at the wellhead prices, certainly today and the forward strip and what could be locked in globally for U.S. gas prices is very compelling. Some have expressed concern about whether we could get regulatory approval, but I point out that we [the United States] export gas every day to Canada and to Mexico as well.”
McClendon also pointed to the announcement Monday by British Columbia-based Kitimat LNG Inc., which now wants to build an LNG export facility instead of an import facility (see Daily GPI, Sept. 23b).
“Whether the gas leaves Canada, Mexico or the United States, any ability by North America to be able to link up to world markets is very, very favorable to all gas producers in North America,” he said. “We try to be at the forefront of new industry, and we want to leave no stone unturned in our search to increase the value of the reserves that we have.”
Other gas-focused producers are likely to follow Chesapeake’s lead, said energy analyst Dan Pickering of Tudor, Pickering, Holt & Co. “This is what Wall Street has been looking for and hoping for,” Pickering said.
Friedman, Billings, Ramsey & Co. Inc. (FBR) analysts concurred.
“To us, this is reflective of capital efficiency, the core of our bearish natural gas call” in July,” wrote FBR’s Rehan Rashid and Michael Jones. “Shale gas, driven by technology, can deliver material production growth at ever declining costs, and if we were to extrapolate [Chesapeake’s] metric to the 1.25 Bcf/d supply imbalance we see by 2010, total industry capex would have to come down by an additional $10 billion cumulatively versus current projected spend of $87 billion in 2008.”
However, the FBR duo said that Chesapeake should further trim its budget.
“While the market may view this as a positive sign, we still see further need to rationalize asses, as supply is fundamentally changing with abundant gas manufacturing from the shales,” noted Rashid and James.
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