Chesapeake Energy Corp., which has been on a tumultuous trip both financially and management-wise over the past year, recorded a profit in 4Q2012, albeit lower than a year ago, but price-related revisions — nearly all related to onshore natural gas assets in the Barnett and Haynesville shales — led to losses for the year.
Net income was $257 million (39 cents/share) in 4Q2012, compared with year-ago profits of $429 million (63 cents). Operating cash flow reached $1.15 billion, versus $1.31 billion. Excluding debt repurchase expenses, adjusted earnings fell to 26 cents/share from 58 cents, which was well above Wall Street’s average forecast of 14 cents on revenue of $2.86 billion.
The latest quarterly earnings gained from $798 million in hedging gains, as well as $166 million on the sale of the midstream subsidiary. For the year, net losses totaled $940 million (minus $1.46/share) on operating cash flow of $4.07 billion.
Chesapeake also recorded a $2.02 billion impairment charge in 2012 on a writedown in the value of its natural gas and oil properties. The writedown took away an estimated 5.4 Tcf from its 15.7 Tcf of proved reserves — the gas is in the ground but it’s not worth producing at this point. While large, the charges didn’t come close to those taken in 2009, when it recorded a $9 billion impairment. For 4Q2008 alone, as the debt crisis impaled U.S. growth, Chesapeake took a $1.8 billion charge (see NGI, Feb. 2, 2009).
Long-time followers of the Oklahoma City driller may have been jarred by the absence of co-founder and CEO Aubrey McClendon, whose oft-times bombastic style and obvious enthusiasm for the onshore portfolio could be counted on keep everyone awake during conference calls. He had presided over about 80 of them.
Thursday was the first in the company’s history in which McClendon was absent, from both the press release and on the call; his retirement is set for April 1 (see NGI, Feb. 4). In a side note, the board last week said a lengthy review of McClendon’s controversial financial transactions, which were publicly disclosed last year, had revealed “no intentional wrongdoing.”
“Based on the documents reviewed and interviews conducted, no intentional misconduct by Mr. McClendon or any of the company’s management was found by the board concerning these relationships and/or these transactions and issues,” the board stated. It also concluded “that the company did not violate antitrust laws in connection with the acquisition of Michigan oil and gas rights in 2010,” which involved Encana Corp. (see NGI, July 2, 2012). Encana’s board in September said it had concluded there had been no price collusion with Chesapeake.
McClendon was fondly noted in a preview to the earnings report by investor relations chief Jeff Mobley, who conveyed a message during the conference call of praise for the departing chief on behalf of the company. McClendon’s “visionary” leadership and abilities, which helped to create the No. 2 natural gas producer in the country, were touted. And the workforce was given a nod for its dedication and loyalty during a particularly rocky time.
Then it was down to business, with COO Steven Dixon and CFO CFO Domenic J. Dell’Osso Jr. attempting to turn the page by detailing where the company is headed. Long story short: natural gas production is bad, liquids are good. And many challenges remain. The company was compelled to sell almost $12 billion in assets last year and needs/wants to sell $5-7 billion this year to repair its balance sheet — it carried $16 billion in debt at the end of 2012 with a market capitalization of less than $14 billion.
The liquids engine is on track, but the company remained gas-weighted in 2012. Gas production rose 3%, or 87 MMcf/d year/year in 4Q2012, to 280 Bcf from 272 Bcf. Quarterly liquids output rose 39%, or 41,300 b/d, with oil jumping 64% to 8.94 million bbl from 5.29 million bbl. Natural gas liquids (NGL) output rose 4% to 4.63 million bbl from 4.13 million bbl. Total production was 362 Bcfe more than year-ago output of 331 Bcfe.
“We continue to deliver on our liquids growth targets, led by a year-over-year increase of nearly 40,000 b/d in oil production,” said Dixon. “We achieved this despite the sale of nearly 18,000 b/d of oil production associated with our exit from the Permian Basin during the 2012 third and fourth quarters. We believe this performance ranks Chesapeake among the top three organic oil growth stories in the industry for 2012.”
Gas, he said, “is now in decline.” The company’s projections see output dropping 7% this year, counting joint ventures and partnerships. Organically, however, “the decline is expected to be 9%, assuming our current guidance.” If gas prices were to strengthen over the coming months, Chesapeake would be ready to prime the pump once again, he noted. But it’s a big “what if.”
Dell’Osso noted that Chesapeake began January 2012 with 164 rigs in operation. By the end of the year the count had been cut almost in half to it 85 rigs, with only a few working natural gas and many being used simply to hold liquids-rich acreage. “We relied on our liquids-rich portfolio to buffer cash flows hit by natural gas declines,” he explained.
Primarily because of lower gas prices, the company for 2012 recorded downward price-related revisions of 5.414 Tcfe, or 902 million boe, mostly related to removing proved undeveloped reserves (PUD) in the Barnett and Haynesville shales. Most of the downward nonprice-related revisions of 1.349 Tcfe resulted from the shift from natural gas to liquids-rich areas. As rigs were reallocated, PUDs were removed from various noncore areas resulting in downward revisions. Last year Chesapeake also recorded net divestitures of 1.305 Tcfe, or 218 million boe.
“We have two major objectives this year: build on our liquids growth and second, to complete the two-year asset divestiture program,” Dixon said. Oil this year is projected to account “for more than 51% of oil and gas revenue,” a major switch for the gas-focused operator.
NGLs have lost their charm, said the COO. “We’re not forecasting any ethane rejection…but we certainly acknowledge that some of it will occur. It depends on processing infrastructure in the Utica,” which makes liquid projections “less clear than oil.” NGLs are expected to account “for less than 10% of the revenue stream in 2013…We see soft markets and they won’t be particularly material.”
Daily production averaged 3.93 Bcfe/d in 4Q2012, which was 9% higher year/year but 5% lower than in 3Q2012. The sequential declines, the company noted, primarily resulted from about 0.22 Bcfe/d of output associated with selling the Permian Basin properties in September and October. Average daily production in the final three months was 3.046 Bcf/d (77% on a natural gas equivalent basis), and 147,500 b/d of liquids, consisting of 97,100 b/d of oil and 50,400 b/d of NGLs.
A commitment by management and the board has been reaffirmed, said Dell’Osso, “to reducing financial leverage of the company through asset sales,” said Dell’Osso. “I would also like to note we have protected a substantial portion of our projected operating cash flows in 2013 through downside hedge protection on approximately 85% of our projected oil production at an average price of $95.45/bbl and approximately 50% of our projected natural gas production at an average price of $3.62/Mcf,” which equates to about 72% of our projected 2013 natural gas, oil and NGL revenue after differentials.
Analysts with Tudor, Pickering, Holt & Co. said the earnings report was “neutral” compared against their estimates. However, they noted that drilling costs are coming down — a positive sign. “Costs are moving in the right direction” both for general/administrative expenses and production. However, Chesapeake has offered “no change” to its 2013 production guidance and the management team provided no color during the conference call on asset sales.
Other energy analysts were more enthusiastic. The Credit Suisse team said it appeared that “the ship may be beginning to turn,” while Wells Fargo’s analysts said Chesapeake “seems to be firing on all cylinders operationally.”
“I think that McClendon’s departure will help remove some of the market’s suspicion about corporate governance practices and bring much greater transparency to the company’s business practices,” said Motley Fool’s Jordo Bivona. “Fortunately, it appears that U.S. gas prices have bottomed out and demand is growing as power plants switch to gas from coal. However, a proper recovery will depend on successful asset sales and debt reduction, as well as an improvement in the cash position. The new management will have to focus on the improvement of operation efficiency, the control of capital expenditures and acceleration of the asset monetization process.”
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