Chesapeake Energy Corp., which has spent the last decade creating one of the largest natural gas drilling machines in the United States, quickly is becoming an onshore liquids dynamo, CEO Aubrey McClendon told financial analysts Tuesday.

The company now plans to cut domestic gas output by 7% in 2013 to pursue more profitable oil and natural gas liquids (NGL), the CEO said during an earnings conference call.

McClendon, who shared a microphone for more than an hour with his management team, detailed the company’s solid quarterly operational and financial performance in 2Q2012. The company’s founder has made few public appearances after being stripped of his chairman title last spring (see Shale Daily, May 2).

An internal investigation continues into some of McClendon’s questionable financial transactions, but legalities prevented the executive team from offering any insight into what has been going on since a reconstituted board of directors and former ConocoPhillips Chairman Archie Dunham took over in June (see Shale Daily, June 22).

For the quarter, the company reported earnings jumped 91% year/year with net profits totaling $929 million ($1.29/share), almost double year-ago earnings of $510 million (68 cents). The greater part of the profit, however, was a one-time gain of $584 million primarily related to the sale of the midstream business. Without special items earnings were $3 million (6 cents/share) in 2Q2012, which was 1-2 cents lower than Wall Street estimates. Long-term debt climbed 9.5% year/year to $14.3 billion, but the company said it still is committed to paring debt to $9.5 billion by the end of this year.

Quarterly operating cash flow totaled $895 million, and revenue climbed 2% to $3.389 billion. Low natural gas prices sent cash from operations down 45% to $755 million in 2Q2012. Lower prices reduced the company’s total oil and natural gas reserves by 7%.

Chesapeake in the latest period added 4.2 Tcfe of proved reserves through the drillbit for the equivalent of about 700 million boe at a finding and development cost of $1.14/Mcfe.

The company’s “drilling machine” is “converting large blocks of undeveloped leasehold in the very large quantities of proved reserves,” said McClendon. “And we believe Chesapeake’s performance can improve even further from this very high level as we progress from operations, designs for new asset identification and capture to a more manufacturing-like operations approach designed to maximize efficiency and returns as we shift more fully in the harvest mode…”

Planned 2013 capital expenditures (capex) now are expected to be about 45%, or $6 billion, lower than in 2012. “Clearly we have listened to investor feedback on this important topic,” said the CEO.

To ensure it can meet its financial obligations, Chesapeake upped its asset sales plans for 2012 by $1.5 billion and now plans to sell $13 billion in assets. About $7 billion in onshore assets — mostly in the Permian Basin — are set to be sold by the end of September.

A portion of the company’s 1.5 million acres in the Midland formation of the Permian Basin is being sold to affiliates of Houston’s EnerVest Ltd. for an undisclosed sum. Two more Permian asset packages in the Delaware play are expected to be completed within the month.

Negotiations to sell “substantially all” of Chesapeake’s remaining midstream assets are also under way with Global Infrastructure Partners (GIP), which already has purchased most of the assets (see Shale Daily, June 11). GIP has an exclusive offer right until next Monday (Aug. 13). Chesapeake also expects to close “various other asset sales” before the end of September.

Assuming it completes all of its planned property sales by the end of the year, Chesapeake expects to repay $4 billion in term loans and achieve a 25% two-year debt reduction goal.

“We anticipate a much higher return to our portfolio than you’ve seen in the past,” McClendon said. Chesapeake had completed $4.7 billion in asset sales at the end of June, he said. Another $4-5 billion in asset sales also are on the table for 2013, said the CEO.

“When we have completed our asset sales, we anticipate Chesapeake will still retain core positions in 10 plays, which we believe will be 10 out of the 15 best plays in the country,” said McClendon. “In each of those 10 plays, Chesapeake will be either the No. 1 or No. 2 producer.”

The 10 plays in which Chesapeake claims to hold the No. 1 or No. 2 positions are the Granite Wash, Cleveland, Tonkawa and Mississippi Lime plays in the Anadarko Basin and the Texas Panhandle; the Marcellus Shale in Pennsylvania and West Virginia; the Haynesville Shale in Louisiana; the Barnett Shale in North Texas; the Eagle Ford Shale in South Texas; the Niobrara Shale in the Powder River Basin and the Utica Shale in Ohio.

Chesapeake’s production averaged 3.808 Bcfe/d in 2Q2012, which was 25% higher year/year and 4% higher than in 1Q2012. Output included 3.027 Bcf/d of natural gas and 130,200 b/d of liquids, which included 80,500 b/d of oil and 49,700 b/d of natural gas liquids (NGL).

Gas output, which has been significantly curtailed from a year ago, still jumped 18% by around 450 MMcf/d in 2Q2012. Liquids output was up 65% from a year ago, or about 51,200 b/d. Oil output rose 88%, or about 37,700 b/d, while NGL production growth was 37%, or 13,500 b/d.

Chesapeake today has 10 dry gas rigs operating in the U.S. onshore; 78 rigs are drilling wetter targets. Most of the gas rigs are operating in the Pennsylvania Marcellus Shale, but by the end of the year the gas rig count will fall to four.

Daily gas production is expected to average 2.9 Bcf/d in 2013, down from an average 3.1 Bcf/d this year. Even with the reductions Chesapeake likely would continue to be the second-largest gas producer in the United States after ExxonMobil Corp.

The company’s total rig count is expected to be about 100 in 2013, just about half from what originally was planned.

“We were planning to run 200 rigs in 2013,” said McClendon, but now “our plan is to run 100. We’ve certainly scaled down.”

Nearly all of the acreage Chesapeake intends to keep within its portfolio today is held by production (HBP), said the CEO. “Less pure HBP” is planned over the coming year and Chesapeake also will slow down operations in areas where infrastructure needs to be built, he said.

By the end of 2013 domestic crude oil output is predicted to jump 80% to 101,379 b/d, while NGL volumes are forecast to rise 30% to 68,484 b/d.

Gas drilling is off the table until prices reach “levels that make returns from drilling in our gas plays competitive with returns available from drilling in our liquids plays,” McClendon told analysts. “In fact, by year-end 2013, we expect Chesapeake’s gas production rate to have declined by 430 MMcf/d, or 14% from our peak rate of 3.4 Bcf/d in 2012.”

Including output from working interest partners and royalty owners, the total decline in Chesapeake-operated U.S. gas production “is likely to be around 800-900 MMcf/d,” said the CEO.

“It won’t be long” before the Energy Information Administration’s 914 data “shows U.S. gas production on a confirmed downward trend. We believe this trend of declining gas production could continue as long as gas prices do not permit gas producers to earn an attractive return on the investments necessary.”

The United States “is likely in a very early stages of a multi-year upcycle in gas markets fundamentals and clear evidence of this new up cycle is readily apparent. Gas prices have bounced strongly upward, from $1.84 level set on April 19, which we believe marks the low in the four-year down cycle that started in 2008.”

The management team and the board of directors are currently reviewing operations for 2013 and beyond, which could result in changes to the company’s drilling activity and production levels in 2013, McClendon said. A drilling update is expected when Chesapeake issues its 3Q2012 earnings.