By next spring U.S. natural gas prices will be $6-7/Mcf and around 900 gas rigs will be operating onshore, Chesapeake Energy Corp. CEO Aubrey McClendon said Tuesday. However, gas producers will be in a world of hurt for the next few months because of a lack of storage capacity, he said.
McClendon offered his take on the domestic gas market, and he and his management team detailed the company’s 2Q2009 performance during a conference call with energy analysts and investors.
Because of continued low wellhead prices, Chesapeake voluntarily curtailed around 400 MMcf/d of its gross output in 2Q2009, which represented around 13% of its total operated production capacity (see Daily GPI, April 17). Although gas prices have barely rebounded, McClendon explained why the company has ramped up the curtailed volumes.
“By holding some production off we certainly did benefit,” he said. The “basis…actually improved pretty dramatically and wellhead prices did improve…The basis story is a really important one.”
The energy industry, said McClendon, “has been long gas and short pipe…We’re getting ready to move into a world where we will be long pipe and short gas, and we have already seen basis differentials…come together…Given where storage is, it was our analysis that we’re going to be full up on storage by the end of the year.
“As we get closer to that, pipeline pressures are going to increase, and that is going to cause involuntary curtailments. Our view was that there was no reason for us to voluntarily curtail gas when pretty soon everybody is going to start involuntarily curtailing gas…We didn’t see any reason to take it on the chin for the team more than we did. Instead, we’ll just let the system work, to spread the pain across the whole industry here over the next couple of months.”
If the industry shuts in gas wells as expected, by early next year gas prices may be double current prices and the gas rig count, now around 675, will be at around 900 rigs, said McClendon.
“We’re probably at a bottom” on the gas rig count, he said. “We don’t expect the rig counts to pop up too many going forward. I would be surprised to see it above 1,000 or 1,100 over the next 12 months or so…I think we’re in a time when service companies are realizing the same things a lot of E&P [exploration and production] companies are realizing: that everything is different as a result of these shale plays. We’re not going back to a service industry supporting 1,700 or 1,800 rigs in the U.S. There will have to be a rationalization of capacity in the industry.
“In the meantime I think most of that capital will stay around and keep prices reasonably low for us.”
CFO Marc Rowland said the key is capacity. U.S. gas producers were running nearly 2,000 rigs at one time, and now more than half of the rigs are down and hydraulic fracturing service equipment “has been stacked, people have been laid off…There is a tremendous amount of recently built-up new capacity that is idled, and I think it will take quite a while even after prices start to return on the gas front before much of that trickles into the service side of things.”
The Oklahoma City-based producer is readying for the long term in any case. It is in “continuing discussions” with several companies about a possible joint venture on “some or all”of its Barnett Shale properties, a deal that should be completed by year’s end. The deal would be one of several already completed or contemplated; an estimated $2.35-3.05 billion of assets may be sold this year and another $1.25-1.8 billion of assets are targeted for sale in 2010.
The asset sales, combined with strong operating cash flow, said McClendon, “will enable the company to continue funding its highly economic investment program solely from internal resources while at the same time reducing the company’s debt levels both absolutely and on a per proved Mcfe basis.”
Chesapeake has sold or agreed to sell around $900 million worth of properties since the end of March. Among other things, a fifth volumetric production payment (VPP) worth $371 million was completed for some producing properties in South Texas. The properties, with estimated proved reserves of 68 Bcfe, currently produce 55 MMcfe/d. The transaction is valued at $5.46/Mcfe.
Another sale worth an estimated $208 million involved some producing and gathering assets in Louisiana. A set of onshore domestic midstream and surface assets was sold for $172 million, and some producing assets in Central Texas were sold for $75 million. Still pending is completion of a $70 million sale to multiple buyers for some midstream assets.
Several transactions also are under way to creatively finance drilling activities in the company’s Haynesville and Barnett plays. Some Haynesville Shale assets worth an estimated $225-250 million are to be sold through another VPP that is scheduled to be completed within the next three months. An undisclosed private equity firm also wants a half stake in some of its Barnett Shale and Midcontinent midstream assets that are worth more than $550 million.
Chesapeake is well known for providing almost to the last detail its quarterly financial and operating information. To help analysts and investors prepare for the conference call, McClendon said the company would provide data ahead of time. Last week the company issued its 2Q2009 operating information (see Daily GPI, Aug. 3). Late Monday the quarterly earnings report was issued.
Net income totaled $237 million (39 cents/share) in 2Q2009, compared with a loss of $1.64 billion (minus $3.16) in 2Q2008. Operating cash flow was $1 billion, versus $1.47 billion a year earlier. Excluding all one-time items, net income was $377 million (62 cents/share). Quarterly results included a one-time realized hedging gain of $597 million.
Chesapeake, which is 92% weighted to natural gas, produced 223 Bcfe in 2Q2009. Average daily production rose 4% sequentially from 1Q2009 to 2.45 Bcfe/d from 2.37 Bcfe/d, and production was up 5% from 2Q2008’s production of 2.33 Bcfe/d. Average quarterly output consisted of 204 Bcf of natural gas and 3.15 million boe of oil and natural gas liquids. Natural gas production rose to 2.04 Bcf/d in the period versus 1.95 Bcf/d in the year-ago period.
Average realized gas prices fell to $5.56/Mcf in 2Q2009 from $8.18 a year earlier. Chesapeake said its gas and oil hedging positions with 14 different counterparties had a positive mark-to-market value of $900 million as of July 31.
“Chesapeake was able to deliver very solid results for the quarter despite the 70% drop in natural gas prices over the past year as a result of our successful hedging program, strong operating capabilities, low cost structure, powerful assets and very attractive joint venture arrangements,” said McClendon. “We are particularly proud of our very strong quarterly proved reserve additions of 741 Bcfe at a finding and net acquisition cost of 72 cents/Mcfe and our outstanding organic reserve additions of 836 Bcfe at a drilling cost of only 87 cents/Mcfe.”
The company “benefited from $311 million of drilling carries and we anticipate receiving more than $3.7 billion of additional carries through 2013,” said the CEO. “We believe these carries, in combination with our very low-cost Big Four shale and two major Granite Wash plays, will result in very high returns on invested capital, reduced capital expenditures and a rapidly improving balance sheet for years to come.” Chesapeake considers its “Big Four” shale plays to be the Haynesville, Fayetteville, Barnett and Marcellus.
“Our high level of hedging at attractive prices should continue to insulate Chesapeake from potentially soft natural gas prices during the remainder of 2009,” he said. “We believe that dramatically reduced U.S. drilling activity should soon lead to steep natural gas production declines in the industry. This should work to tighten natural gas markets, lift natural gas prices and improve the company’s profitability in 2010 and beyond.”
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