Oil and natural gas price increases have “far outpaced” acquisition cost increases because margins matter, not the “per Mcfe sticker price,” Chesapeake Energy Corp. CEO Aubrey McClendon said Tuesday. Holding to that strategy, the Oklahoma City-based independent plans to continue to acquire more domestic onshore assets to increase its ever-growing gas reserves.
McClendon spoke at Lehman Brothers CEO Energy/Power Conference in New York City. He acknowledged Chesapeake probably is as well known as an asset acquirer as it is a gas producer. But he likes the reputation and has no plans to change it.
“Our strategy is very simple,” McClendon told financial analysts. “All we care about is balance and growth between acquisitions and the drill bit.”
Chesapeake is the seventh largest U.S. gas producer overall, but it is the third largest independent, behind only Anadarko Petroleum Corp. (now combined with Kerr-McGee Corp. and Western Gas Resources) and Devon Energy Corp. It stands alone as the leading independent gas-focused onshore producer, along with carrying the title as the number one driller in the country.
“Every day we see more shale than any other company in America,” he said. It makes the company a high-profile gas producer, but also gives it “first mover advantages” when attractive properties come up for sale. In 1998, Chesapeake had about 750 Bcfe of proved reserves. Today that figure is near 6,300 Bcfe. Proved and unproved reserves in 1998 also stood at 750 Bcfe. Today the number is 11,330 Bcfe. And even though costs have increased, the opportunities remain, said McClendon.
“Acquisition margins remain attractive,” he said. The 2006 New York Mercantile Exchange natural gas futures price of about $8.64, combined with Chesapeake’s realized hedging gains through August, have resulted in an eight-year compound annual growth rate of 16.8%. Chesapeake’s all-in acquisition cost now stands at $10.08/Mcfe.
“Inexperienced or occasional buyers generally do not succeed,” he said. “Chesapeake has a consistent approach to acquiring and assimilating acquisitions.” The company is “always in the market,” with about 50 people working full-time on acquisition integration. “Our strategy is paying a little more than the market says we should pay…, but we buy and hedge, buy and hedge.”
The company’s success also can be traced to its tremendous success through the drill bit. “That’s where you make the most money. Acquisitions are nice, but you make much more through the drill bit. But you had to be thinking about this five years ago. The land grab is over.”
Chesapeake began to zero in on the domestic gas onshore when it refocused its business strategy in 1998.
“We thought that supply and demand fundamentals would steadily improve,” said McClendon. “We saw the demand trend line would be up 1-3% a year, and the supply trend line would be down, zero to 2% per year.” Believing there would be “higher highs and higher lows” in gas prices, Chesapeake embraced the strategy and the rest, as they say, is history.
“Volatility is high and likely to increase,” said McClendon. “We love gas price volatility. Why? Volatility creates the opportunity to hedge unusually high prices that generate unusually high returns.”
Liquefied natural gas (LNG) growth is a “risk to be monitored,” McClendon added. “But our view is that U.S. gas prices will need to approximate Btu parity with world oil prices to attract LNG imports in the 2009 and beyond time frame. Worldwide liquefaction capacity rather than U.S. regas capacity will be the bottleneck. Recent summer storage withdrawals set the stage for even better future market dynamics,” and decreasing gas available for injection in the summer may offset future LNG risks.
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