Chesapeake Results Confirm Upside, Shale Sale Looks Like a Bargain

Founded in 1989, Chesapeake Energy (NYSE:CHK) has grown to become the second largest producer of natural gas and one of the most active drillers of new wells in the U.S. Chesapeake competes with other oil and gas producers like Exxon Mobil (NYSE:XOM), ConocoPhillips (NYSE:COP), Anadarko (NYSE:APC), BP (NYSE:BP) and Chevron (NYSE:CVX). Chesapeake owns interests in around 44,100 producing natural gas and oil wells that are currently producing around 2.4 billion cubic feet equivalent (bcfe), 93% of which is natural gas.

We estimate that natural gas production accounts for around 78% of our near $37.57 price estimate for Chesapeake’s stock, which is in line with the current market price.

Solid Results Buoy Chesapeake

Chesapeake reported fourth quarter earnings last week. Its net revenues increased by just over 20% with revenues from natural gas and oil sales increasing by around 12%.  The natural gas production increased by around 10% and oil production increased by around 55%. The average sales price for the company’s natural gas increased by around 8% while that for oil increased by around 5%. In 2010, the company continued the industry’s most active drilling program. It drilled 1,445 gross operated wells (938 net wells with an average working interest of 65%). It also participated in another 1,586 gross wells operated by other companies (211 net wells with an average working interest of 13%). The company’s drilling success rate was 98% for both company-operated and non-operated wells. ^[1]

Shale Deal Announced

Also last week, Chesapeake announced that BHP Billiton was buying its Fayetteville Shale natural gas reserves for $4.75 billion in cash. The sale of this shale play, spread over 487,000 net acres, is partly motivated by the company’s target of reducing its debt balance by 25% over the next two years. ^{[2] [3]}

The Fayetteville shale play constitutes around 15% of the company’s total proven reserves. The total natural gas production from this play was around 10% of the total production of 834.8 bcf in 2009. With the sale of this shale play, if Chesapeake’s natural gas production volume goes down by 10% during our forecast period, it would mean around 15% downside to our current price estimate for Chesapeake’s stock. We have an estimated firm value of $24 billion before the asset sale, and so a 15% reduction in value corresponds with a value of $3.6 billion. This ignores the impact on the cost of debt for Chesapeake. While this is a rough estimate, if BHP pays $4.75 billion for these assets, this sounds like a nice deal for Chesapeake.

You can drag the trend line in the chart above to make estimates of how the value of this production could impact Chesapeake.

1. Chesapeake Reports 4Q and Full Year Results [↩]
2. Chesapeake Energy Announces the Sale of Fayetteville Shale Assets to BHP Billiton [↩]
3. BHP to Buy Chesapeake Shale Assets [↩]