I’ve been writing pretty regularly about Chesapeake Energy. I’ve been circling it for months as I think it is likely VERY undervalued at current prices and has a couple of options for even further upside. Those options being a large move to oil and the possibility of an improvement in natural gas prices.
http://valueinvestorcanada.blogspot.com/search/label/CHK
The share price is currently about $22 with a fair valuation likely more than double that (see prior articles for some valuation details). I believe what we have here is a discount related to the CEO and his 2008 margin call and just general distaste for natural gas.
On Aggressive Oil/Liquids Growth Plans
We are currently producing more than 55,000 barrels of liquids per day and have our sights set on exceeding 150,000 barrels per day by year end 2012 and 250,000 barrels per day by year end 2015. We think that will make us a top five producer of liquids in the U.S. by the end of 2005.
Our latest JV, the CNOOC deal in the Eagle Ford, is expected to close in the near future. And our data room is open for the Niobrara Shale JV, in which we own 800,000 net acres, evenly split between the Powder River and D-J Basins. We expect to also sell a 33% working interest in this play at what we believe will be an attractive price both to us and to our future partner.
We believe the recoverable resource under our 800,000 net acres is an unrisked approximate 4.6 billion barrels of oil, representing potentially $400 billion of future undiscounted revenue. This is a reminder that the size of the plays that we have chased and have captured is quite remarkable.
Some of you may be wondering what's next in our liquids plays. I can tell you that we have several new plays under evaluation or development, including an almost 100,000-acre new position in the Williston Basin and a 1 million-acre position in another play that will probably be ready for disclosure in the JV data room in the first half of 2011. We believe there will be worldwide interest in this next big play of ours.
On Building a Top 10 Natural Gas Producer Inside CHK Every Year
Next, I'd like to highlight our exceptionally low finding cost during the first nine months of the year. We added, on a gross basis, 4.0 Tcfe of proved reserves at a drilling and completion cost of only $0.97 per Mcfe. Basically, we are building a top 10 U.S. natural gas producer every year inside our company, an incredible achievement we believe.
And not only are we good at finding gas cheaply at the $0.97 per Mcfe level, we are also good at selling it for much more. To date this year, we have received well north of $3 per Mcfe when we have sold properties through VPPs. It's always good to buy low and sell high, and that's what we try to do around here, whether it's leasehold or proved reserves.
Well Hedged for 2011 and Huge Benefit From Partner Drilling Carry
Finally, I'd like to point out that our realized cash hedging gains since 2001 now reached almost $6 billion. In addition, we have hedged approximately 80% of our anticipated gas production in the first half of 2011 with swaps at an average strike price of $6.35 per Mcf and approximately 43% in the second half of 2011, the swaps at an average strike price of $6.61 per Mcf. If today's 2011 strip holds true, we should record another $1.5 billion in hedging gains in 2011.
That $1.5 billion, along with an expected $2 billion in drilling carried in 2011, will provide Chesapeake with $3.5 billion in cash from two important competitive advantages and what most expect will be a tough industry environment in 2011. We also expect to generate more than $1.5 billion in cash and $1.5 billion in additional drilling carries from two new JVs that we should close in 2011. So that's a total of $6.5 billion in competitive advantages before we even consider the expected $3.5 billion in operating cash flow we should generate in 2011 without any hedges.
The Market Doesn’t Appreciate The Impact of Shifting From Natural Gas to Oil
If you're on our website or go to it at some point, note Slide 17, which is a projected CapEx budget over the next, well, I guess, three years going out to 2012. And in 2010, we'll spend 31% of our money on liquids CapEx, 2011 that should be 45%. And by 2012, we'll be spending almost 2/3 of our capital on liquids plays. So I suspect that people really don't appreciate that impact when we start replacing $3 and $4 Mcf with $13 and $14 Mcf. On a similar cost basis, you really see a huge move in per-unit value creation, and that will drive some numbers in 2012 and beyond and I think most people are not currently not modeling for. So that will remain a focus of the company. Of course, if gas prices, for some reason, were to come back at higher levels, we can always pick our gas drilling back up. But at this point, our goal is to go from 90% natural gas CapEx in 2009 to go to 35% gas CapEx in 2012.
On Deleveraging the Company Through Production Increases
Joseph Allman - JP Morgan Chase & Co
Aubrey, on the same topic, do you still plan to reduce debt and become investment grade? Or have other priorities risen to the top?
Aubrey McClendon
That's still the plan, Joe. When we look out by year end 2012, we think we'll be a 22 to 24 Tcfe company. That's almost 4 billion barrels of oil. By that time, we shouldn't have more than $10 billion of debt. So is $0.40 in Mcfe or $2.50 per barrel debt, are those investment-grade stats by year end 2012? Absolutely. Looking at our book cap today, I guess, guys what's our debt? 42%. Our debt's 42%. If you just look at the earnings capability of the company over the next few years, we will be earning close to $2 billion a year. You'll see that percentage continue to drop. So we absolutely think we're there. And our goal is to drop absolute levels of debt, which we've stated as our goal. But certainly, on a relative basis, as we increase our reserves by 2 1/2, 3, 3 1/2 Bcf per year or Tcf per year, rather, you will see that drop very dramatically on a relative basis for sure.
On Recently Increasing Production Guidance
You bet. Good question, Steve. Let's talk about, first of all, the change in production guidance. For 2010, we did previously have just a spot number for our oil production at 19 million barrels. We went ahead and added a range there of 18 million to 19 million, and that really reflects some ethane rejection that occurred that took our NGL barrels down. We haven't properly accounted for that in our models and now are doing a better job of that. And then also some pickup delays related to some Midstream activity. So we'll see where we come out there, but we felt like it was prudent to put a range in rather than just a spot number of 19 million barrels. And then in 2012, I think Nick mentioned this, but just greater clarity on some of our plays, particularly the Eagle Ford, and I think I might have mentioned the Niobrara as well. So that's been able to give us that clarity. What's that mean with regard to our thoughts about gas prices? I mean, I think we just have to live with today's reality, which is the projection for gas prices going forward and comparing that to the curve would make anybody with a choice of drilling an oil well or drilling a gas well be inclined to drill an oil well. And so that's what we're doing. And then three years ago or so, we were a single-product company focused only on natural gas. We didn't really think we could find oil in any meaningful quantities. We didn't want to go out and buy it. But all that's changed in the last three years, and we have figured out a way to find liquids. And so we're going to back down our gas drilling over time. And again, as I mentioned before, we'll be down to a third of our drilling in 2012 will be gas compared to 90% last year. If gas prices rebound and the country says we need more gas, we can absolutely respond to that very quickly. But right now, the focus is on oil, because it's 3x or 4x more profitable to look for it than it is natural gas.
My Comments
I’ve been following this company since at least 2006. They are a reserve and production growth machine. Really, the only problem they have had is that they and others have been too successful in increasing natural gas supplies for the United States.
I think this is probably a decent investment if natural gas ranges between $4 and $6 for the next few years. There is potential for a multi-bagger return here if either 1) natural gas moves up into a higher range of $6 to $8 2) Aubrey isn’t blowing smoke about the size of the unconventional oil prize he is amassing.
Given what they did with unconventional natural gas reserves, I’m not sure why I shouldn’t believe that they can do something impress of on the oil/liquids side.
I currently have a very small position. If I get any chance under $20 I will be buying aggressively, and I may do so at these prices as well. Right now I’m just trying to be patient and make sure I’m 100% committed to this investment.
http://valueinvestorcanada.blogspot.com/search/label/CHK
The share price is currently about $22 with a fair valuation likely more than double that (see prior articles for some valuation details). I believe what we have here is a discount related to the CEO and his 2008 margin call and just general distaste for natural gas.
On Aggressive Oil/Liquids Growth Plans
We are currently producing more than 55,000 barrels of liquids per day and have our sights set on exceeding 150,000 barrels per day by year end 2012 and 250,000 barrels per day by year end 2015. We think that will make us a top five producer of liquids in the U.S. by the end of 2005.
Our latest JV, the CNOOC deal in the Eagle Ford, is expected to close in the near future. And our data room is open for the Niobrara Shale JV, in which we own 800,000 net acres, evenly split between the Powder River and D-J Basins. We expect to also sell a 33% working interest in this play at what we believe will be an attractive price both to us and to our future partner.
We believe the recoverable resource under our 800,000 net acres is an unrisked approximate 4.6 billion barrels of oil, representing potentially $400 billion of future undiscounted revenue. This is a reminder that the size of the plays that we have chased and have captured is quite remarkable.
Some of you may be wondering what's next in our liquids plays. I can tell you that we have several new plays under evaluation or development, including an almost 100,000-acre new position in the Williston Basin and a 1 million-acre position in another play that will probably be ready for disclosure in the JV data room in the first half of 2011. We believe there will be worldwide interest in this next big play of ours.
On Building a Top 10 Natural Gas Producer Inside CHK Every Year
Next, I'd like to highlight our exceptionally low finding cost during the first nine months of the year. We added, on a gross basis, 4.0 Tcfe of proved reserves at a drilling and completion cost of only $0.97 per Mcfe. Basically, we are building a top 10 U.S. natural gas producer every year inside our company, an incredible achievement we believe.
And not only are we good at finding gas cheaply at the $0.97 per Mcfe level, we are also good at selling it for much more. To date this year, we have received well north of $3 per Mcfe when we have sold properties through VPPs. It's always good to buy low and sell high, and that's what we try to do around here, whether it's leasehold or proved reserves.
Well Hedged for 2011 and Huge Benefit From Partner Drilling Carry
Finally, I'd like to point out that our realized cash hedging gains since 2001 now reached almost $6 billion. In addition, we have hedged approximately 80% of our anticipated gas production in the first half of 2011 with swaps at an average strike price of $6.35 per Mcf and approximately 43% in the second half of 2011, the swaps at an average strike price of $6.61 per Mcf. If today's 2011 strip holds true, we should record another $1.5 billion in hedging gains in 2011.
That $1.5 billion, along with an expected $2 billion in drilling carried in 2011, will provide Chesapeake with $3.5 billion in cash from two important competitive advantages and what most expect will be a tough industry environment in 2011. We also expect to generate more than $1.5 billion in cash and $1.5 billion in additional drilling carries from two new JVs that we should close in 2011. So that's a total of $6.5 billion in competitive advantages before we even consider the expected $3.5 billion in operating cash flow we should generate in 2011 without any hedges.
The Market Doesn’t Appreciate The Impact of Shifting From Natural Gas to Oil
If you're on our website or go to it at some point, note Slide 17, which is a projected CapEx budget over the next, well, I guess, three years going out to 2012. And in 2010, we'll spend 31% of our money on liquids CapEx, 2011 that should be 45%. And by 2012, we'll be spending almost 2/3 of our capital on liquids plays. So I suspect that people really don't appreciate that impact when we start replacing $3 and $4 Mcf with $13 and $14 Mcf. On a similar cost basis, you really see a huge move in per-unit value creation, and that will drive some numbers in 2012 and beyond and I think most people are not currently not modeling for. So that will remain a focus of the company. Of course, if gas prices, for some reason, were to come back at higher levels, we can always pick our gas drilling back up. But at this point, our goal is to go from 90% natural gas CapEx in 2009 to go to 35% gas CapEx in 2012.
On Deleveraging the Company Through Production Increases
Joseph Allman - JP Morgan Chase & Co
Aubrey, on the same topic, do you still plan to reduce debt and become investment grade? Or have other priorities risen to the top?
Aubrey McClendon
That's still the plan, Joe. When we look out by year end 2012, we think we'll be a 22 to 24 Tcfe company. That's almost 4 billion barrels of oil. By that time, we shouldn't have more than $10 billion of debt. So is $0.40 in Mcfe or $2.50 per barrel debt, are those investment-grade stats by year end 2012? Absolutely. Looking at our book cap today, I guess, guys what's our debt? 42%. Our debt's 42%. If you just look at the earnings capability of the company over the next few years, we will be earning close to $2 billion a year. You'll see that percentage continue to drop. So we absolutely think we're there. And our goal is to drop absolute levels of debt, which we've stated as our goal. But certainly, on a relative basis, as we increase our reserves by 2 1/2, 3, 3 1/2 Bcf per year or Tcf per year, rather, you will see that drop very dramatically on a relative basis for sure.
On Recently Increasing Production Guidance
You bet. Good question, Steve. Let's talk about, first of all, the change in production guidance. For 2010, we did previously have just a spot number for our oil production at 19 million barrels. We went ahead and added a range there of 18 million to 19 million, and that really reflects some ethane rejection that occurred that took our NGL barrels down. We haven't properly accounted for that in our models and now are doing a better job of that. And then also some pickup delays related to some Midstream activity. So we'll see where we come out there, but we felt like it was prudent to put a range in rather than just a spot number of 19 million barrels. And then in 2012, I think Nick mentioned this, but just greater clarity on some of our plays, particularly the Eagle Ford, and I think I might have mentioned the Niobrara as well. So that's been able to give us that clarity. What's that mean with regard to our thoughts about gas prices? I mean, I think we just have to live with today's reality, which is the projection for gas prices going forward and comparing that to the curve would make anybody with a choice of drilling an oil well or drilling a gas well be inclined to drill an oil well. And so that's what we're doing. And then three years ago or so, we were a single-product company focused only on natural gas. We didn't really think we could find oil in any meaningful quantities. We didn't want to go out and buy it. But all that's changed in the last three years, and we have figured out a way to find liquids. And so we're going to back down our gas drilling over time. And again, as I mentioned before, we'll be down to a third of our drilling in 2012 will be gas compared to 90% last year. If gas prices rebound and the country says we need more gas, we can absolutely respond to that very quickly. But right now, the focus is on oil, because it's 3x or 4x more profitable to look for it than it is natural gas.
My Comments
I’ve been following this company since at least 2006. They are a reserve and production growth machine. Really, the only problem they have had is that they and others have been too successful in increasing natural gas supplies for the United States.
I think this is probably a decent investment if natural gas ranges between $4 and $6 for the next few years. There is potential for a multi-bagger return here if either 1) natural gas moves up into a higher range of $6 to $8 2) Aubrey isn’t blowing smoke about the size of the unconventional oil prize he is amassing.
Given what they did with unconventional natural gas reserves, I’m not sure why I shouldn’t believe that they can do something impress of on the oil/liquids side.
I currently have a very small position. If I get any chance under $20 I will be buying aggressively, and I may do so at these prices as well. Right now I’m just trying to be patient and make sure I’m 100% committed to this investment.
