Natural gas prices are poised to break out of their $6-8 range due to a number of factors and could trade in an $8-10 range for the next two years or so, said Chesapeake Energy Corp. CEO Aubrey McClendon.
“Chesapeake has been extensively hedged during the past two years, and it has turned out to be a good decision as we have made $2.5 billion in 2006 and 2007 from our hedging activities,” McClendon told financial analysts during a fourth-quarter earnings conference call last week. “Looking forward, however, we see many bullish factors that have developed and are evolving over time that lead us to conclude that natural gas prices may have upside in them during the next two years.”
Factors lending support to prices are high oil prices, higher coal prices, emerging environmental trends and “for the first time in a long time winter weather that this year is near the 30-year average and above the 10-year average. All of these factors are supportive of stronger natural gas prices than we have seen during the past two years,” McClendon said.
“I believe we are seeing a multi-year trend develop for prices that could keep them in the $8-10 range instead of the $6-8 range in which we have been stuck for the past two years. I believe this new higher range is especially likely to be sustainable if summer weather is hot this year, particularly in key southern electricity markets. I would remind you in the past, strong La Nina summers’ bias has been toward warmer weather, and this current La Nina is bordering on the strongest La Nina event ever recorded.”
Stronger prices on the Nymex strip have allowed the company to hedge more, noted CFO Marc Rowland. “It’s a great environment to be in from a hedging standpoint,” he said. “We are continuing to execute, just like we have in the past, opportunistically to create higher revenue units per molecule sold, and we’re doing that both in the oil markets and the gas markets.”
McClendon noted that unit costs are declining as service industry capacity continues to expand faster than the rig count is increasing. At the same time, stronger gas prices should allow the company to accomplish multi-year hedging at or above $10.
Proved reserve growth at the Oklahoma City-based producer is projected to be 2 Tcf/year, and those reserves should be worth $7-8 billion/year in value, McClendon said. Further, unrisked, unproved reserves should increase by at least 5 Tcfe, he said, noting these are worth about $1/Mcfe. The CEO said that for every 10-cent increase in gas prices, the value of the company’s proved reserves increases by almost $400 million, or 80 cents/share. “Given that I believe the strip is likely to move up by $1 per year in each of the next two years, that could create an additional $4 billion in value per year,” he said.
“You add it all up you get around $16-17 billion of potential value creation per year, or around $30/share. I then aggressively risk this at 50%…We should be able to increase the value of Chesapeake stock by about $15/share during each of at least the next two years without anything out of the ordinary…”
McClendon in the past has eschewed the Rockies as offering opportunity to his company, sticking instead in the Midcontinent and Appalachia. The Rockies Express Pipeline (REX) is poised to significantly improve the market for Rockies producers, but McClendon said he doesn’t think the good times will last long. Further, he said he doesn’t see REX as a major threat to Midcontinent producers, such as Chesapeake.
“We’ve followed REX like everyone else in the industry, and from what we’ve read it seems like that we have seen somewhere between 300 and 500 MMcf/d of incremental supplies [come from REX],” he said. “It’s been relatively cold in the Rockies and, of course, in California as well, so not as much gas has made it east as perhaps some people had predicted.
“Down the road the question really is on basis, will it affect Midcontinent basis? We haven’t really seen that it has so far this year. We are about as well protected as we could be from basis hedges…Going forward, we think the Rockies will probably always be challenged from a basis differential standpoint as every pipeline project that’s ever been built there has promised a permanent salvation from high basis differentials and within a matter of months to a year or so the pipe gets overrun. And we would expect that to be true [of REX] as well.”
Chesapeake’s average daily production was 2.22 Bcfe in 4Q2007, up from 1.65 Bcfe in the year-ago period. For the year average daily production was 1.96 Bcfe, up from nearly 1.59 Bcfe in the year-ago period. Natural gas was 92% of production in 4Q and full year 2007 and 91% in the 2006 periods. The average realized gas price was $8.11/Mcf in 4Q2007 and $9.03 in the year-ago period. For the full year the average realized gas price was $8.14/Mcf in 2007 and $8.76 in 2006.
Net income for 4Q2007 was $303 million (33 cents/share) compared to $471 million (96 cents) in the year-ago period. Full year net income was $1.45 billion ($2.62/share) compared to $2 billion ($4.35) in the year-ago period.
Adjusted net income, which excludes special items, was $466 million (93 cents/share) in 4Q2007, and adjusted earnings before interest, taxes, depreciation and amortization (ebitda) was $1.4 billion. For the full year adjusted net income was $1.6 billion ($3.21/share), and adjusted ebitda was $5 billion. Special items were an unrealized after-tax mark-to-market loss of $180 million in 4Q2007 and $257 million for the full year on oil, gas and interest rate hedging; an after-tax gain of $51 million in 2Q2007 from the sale of the company’s stake in Eagle Energy Partners I LP; and a reduction in net income of $128 million for 4Q and full year 2007 from exchanges of preferred for common stock.
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