Chesapeake Earnings Call Sheds Light On the Best Unconventional Resource Assets in the Industry
I’ve made some notes from the Chesapeake Q2 earnings call which I listened to a couple of times:
Recap of Opening Comments from CEO Aubrey McClendon
Details on Four of Chesapeake’s Liquid Plays (little had been disclosed prior to now)
Play #1 - Mississippi Lime Horizontal Play
- CHK discovered in April 2007 with a well that cost $2.7 million which found 285,000 BOE of reserves
- In 2007 CHK also discovered their Colony Granite Wash play which they decided to develop first because they were uncertain of how large the Mississippi Lime play would be or how predictable the rocks would be
- Became clear later the Mississippi Lime is a major play so they ramped up leasing and drilling
- Now have 1.1 million net acres and using 6 rigs
- Anticipate 10 rigs by year end 2011 and 30 to 40 rigs by year end 2014
- Have drilled 56 wells to date and have found an average of 415,000 BOE per well
- Planning to develop the 1.1 million acres with 160 acre spacing which means 6,750 net wells
- In total 2.2 billion BOE unrisked to CHK
- Expect a JV on this play in the first half of 2012
Play #2&3 – Cleveland and Tonkawa play (located in Anadarko basin of western Oklahoma)
- Distinct and separate tight sand formations, but Cleveland and Tonakawa plays are close enough together than CHK combines them
- CHK 720,000 acres is so dominant that no other E&P has been able to build a meaningful position
- This is why not much has been said about the play
- Dominance is due to CHK long being the dominant player in the Anadarko Basin from building up a conventional natural gas acreage
- This huge acreage position gives CHK unique informational and operational advantages which has enabled them to discover several new plays
- Anadarko Basin now one of the premier liquids focused basins with the Permian being the other
- CHK owns 2 million acres in the Anadarko and believe 720,000 to be prospective for the Cleveland and Tonkawa
- Have drilled 116 wells to date with estimated 600,000 BOE per well, finding and development costs of $12 per barrel
- Now have 16 rigs and expect to increase to 30 over coming years
- Expect to use 160 acre spacing, which means 4,400 wells and 2.0 BOE unrisked to CHK
Play #4 – Utica Shale
- Confirming rumours that CHK has made major liquids rich discovery in the Utica Shale of eastern Ohio
- Reminds them of Haynesville Shale in that they worked undercover for more than a year to develop the basic geological and petrophysical model.
- Built largest leasehold in play then drilled first discovery wells.
- Looks similar to the Eagle Ford in that they expect dry gas on the eastern side of the play, wet gas in the middle and oil on the western side.
- Expect it will be economically superior to the Eagle Ford because of the quality of the rock and location of the play
- Not ready for competitive reasons to disclose well results to date
- Have drilled 6 horizontal wells, have analyzed 3,200 feet of core sample and over 2,000 well logs that have penetrated the Utica
- Believe that their 1.25 million acres in Utica should be worth $15 billion to $20 billion
- The only other public company with an acreage position of any real size in the core of the Utica is EnerVest.
- Started with 1 rig 7 months ago, are now up to 5, expect to reach 40 by year end 2014
Some Observations By McClendon On Chesapeake’s Production
- Discovered by CHK in 2007
- Current gross production is 1.7Bcf per day
- Has been built 100% organically in 4 years
- If Chesapeake’s Haynesville asset was a stand alone company it would be the seventh largest gas producer in the United States
- First CHK production in 2004
- Current gross production 1.25 Bcf
- Remain second largest producer behind Devon
- First CHK production in 2008
- Current gross production is 730 million cubic feet of gas per day
- Top producer in the play
- Discovered by CHK in 2007
- Current gross production is 420 million cubic feet of gas per day
- Top producer in the play
Permian Basin Horizontal Plays
- First CHK production in 2007
- Current gross production 100 million cubic feet equivalent per day
Eagle Ford Shale
- First CHK production was in 2010
- Current gross production is 20,000 BOE
- Fourth largest producer in play
Cleveland and Tonkawa
- Discovered by CHK in 2008
- Current gross production is 25,000 BOE per day
- Largest producer in play
Total From All of These Plays
- 4.5 Bcf per day in gross production from plays that didn’t exist 4 years ago
- Remarkable achievement
- Shows how fast production can be ramped up
- If CHK had not sold their Fayetteville assets earlier in the year CHK year over year production growth would have been 700 million cubic feet of gas equivalent per day which happens to basically equal the same daily production of Petrohawk, Newfield and Pioneer each of which have enterprise values of $15 billion per company
- Another metric is that this 700 million per day production growth is the same amount of production that Concho and Sandridge have on a combined basis and combined these two companies have a $20 billion enterprise value
Gas Drilling Slowdown Well Underway
- From high watermark of 36 rigs which were needed to HBP their acreage CHK is now down to 33 rigs in the Haynesville and Bossier.
- 9 of the 33 are drilling their last wells and will be released within 30 days
- Expect to be down to 15 Haynesville and Bossier rigs by year end 2011 and hold that constant until natural gas prices improve
- This type of slow down should be bullish for natural gas
Observations From the CFO’s Comments
Rapidly Growing Liquids Production
Liquids production was up 19% quarter-over-quarter and 62% year-over-year. This quarter, 16% of our total production came from oil and natural gas liquids, which equated to 28% of our revenue. We are very quickly becoming leveraged to oil. In addition, our natural gas production continues to grow, causing us to increase our 2-year estimated production growth rate to 30%.
Therefore, as of today, our 25/25 Plan officially becomes the 30/25 Plan. And it's my hope that before year-end 2012, the plan may be amended once again to accommodate further debt reduction and that it becomes known as the 30/30 Plan.
And Rapid Reserve Growth
On the reserve front, we announced yesterday evening that we added 2.7 Tcfe of proved reserves in the first half of the year. Coincidentally, that's approximately the same amount of proved reserves we sold in our Fayetteville Shale transaction for $4.65 billion, giving another data point to support the value-creation machine we have here at Chesapeake. Additionally, from the value perspective, the Fayetteville reserves were 100% gas. The reserves we replaced them with, through the drillbit, were 31% liquids and cost us only $1.29 per Mcfe to find and develop.
As a reminder, the PV-10 of our proved reserves at the 10-year NYMEX strip on June 30 is $27.4 billion or 70% of our $39-billion enterprise value. Of course, in addition to our proved reserves, we hold $4 billion of midstream assets, $7 billion of oilfield service assets, $3.5 billion of drilling carry and over $2.7 billion of other assets and investments, which totals about $44.5 billion.
We look forward to continuing to execute on our plans and closing the net asset value gap for you all, where based on the items I've just ticked off, investors are getting our 13.2 million undeveloped acres, which we estimate hold about 18 billion barrels equivalent of risked, unproved resources, for less than 0, pretty remarkable opportunity for value.
Advantage of the CHK Integrated Model
Based on a recent internal analysis, we completed on the Eagle Ford, we estimate that when we drill a well with our own service company assets, our drilling and completion costs are 17% lower than when drilled with third-party providers. Also, we have invested approximately $1.2 billion in our oilfield services assets to date, inclusive of our Frac Tech stake and believe they are worth approximately $7 billion today.
Notes from the Q&A
- McClendon clarifies that he thinks the $15 billion to $20 billion value they have suggested for the Utica is the value today in its undeveloped state. Will be worth more as developed on a PV10 basis
- McClendon on whether they should be splitting this company up to try and get value recognized….
o Smaller company wouldn’t have been able to take on the risk to build a million acre Utica Shale position that cost $2 billion
o Collection of oilfield service assets gives them a hedge against rising service costs
o Scale and size enables them to assemble these large plays
o Thinks partial monetizations to bring forth value appropriate
- Expect that they can develop all of these plays using JVs to help fund, as well as the leverage from moving production to higher value liquids AND keep debt where it is and no stock issuance
- Asked about why their natural gas production is beating expectations, McClendon suggests that it is because of the exact opposite of what you read in the NY Times (meaning that as you drill wells in these plays they get better not worse)
- In the old days under conventional production your first well was your best well. Now the worst wells are drilled first because you learn how to improve performance in these resource plays
- Much of the acreage in the Utica play is already HBP because they bought deep rights from shallow producers like EnerVest and Anschutz
- Will do some sort of JV in the Utica with an up front cash component which will get their original investment back and accelerate drilling
- Industry has a shortage of oil hauling trucks, a shortage of drivers and a shortage of pipelines
- Planning for virtually all production growth going forward to come from liquids with gas production growing slightly
- Utica JV monetization process is already well underway, CHK has no preference who they partner with.
- Every quarter the credit worthiness of CHK increases as their asset value grows and debt amount stays basically the same.
- On why they decided to release the details of the Utica position now…have reached the point where they have producing wells and thought waiting until next quarter would be too long
- In response to what environmental concerns they have….refer to their being massive confusion about the actual hydraulic fracturing process. They have done it 15,000 times and have been surprised by the concerns raised recently. CHK has been taking people out and showing them what hydraulic fracturing actually entails after which the observer can’t understand what he was supposed to be worried about.
- Have been building a position in the Bakken (Williston Basin) which is now about 400,000 acres, have permitted some wells but not drilled them. Not saying much, other than they are late to the basin which might suggest that they have a different target or different idea than other folks have
Perhaps the hardest thing to do is buy a stock after it has already had a big increase. Chesapeake has gone from $22 at this time last year to almost $35 today. That is a 60% increase, most of which has actually happened in just the last six months.
But you can’t focus on what the stock has done. As an investor you need to focus on what the company and its assets are worth. And when you find out about a major new resource play like the Utica shale that Chesapeake has the value of the business today has changed significantly from a year ago. So what the stock price was a year ago really isn’t relevant.
The Utica Shale by itself is likely worth $20 billion (according to CHK) and this is more than $20 per Chesapeake share. So it is not only as if the $12 share price increase from a year ago didn’t happen, the value proposition has actually improved ($20 per share of value added, only a $12 per share stock price increase). This is especially true when you consider that oil prices have also increased from $70 to almost $100 over the same time period.
I believe Chesapeake continues to be what it has long been. And that is a company run by a charismatic and sometimes controversial CEO who has assembled an asset base that is significantly undervalued.
And I believe the really underappreciated thing about Chesapeake is that five years from now this huge resource base they have assembled may be worth much, much more as technology improvements allow for even more oil and gas in place to be recovered.