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Investment Overview for Chesapeake (NYSE:CHK)
WHAT HAS CHANGED?
- Increased focus on cost optimization in a low oil price environment
Capital expenditure, which is the biggest single cash expense item in this business, and the primary driver for future production and earnings growth, plans of independent exploration and production companies, are significantly dependent on the short to medium term outlook for global crude oil prices. This is one of the key reasons behind Chesapeake's recent capital expenditures guidance revision.
In view of the changed commodity price environment, Chesapeake has announced that it will spend around $3.5 to $4 billion in gross capital expenditures this year, about 45% less than what it did last year. Lower capital expenditures mean lower investment in future production growth. Therefore, while lower capital spending will improve the free cash flows to the firm, we believe it will also slow down the company’s short to medium-term production growth. For example, last year, Chesapeake’s liquids production grew by almost 21% y-o-y, but we expect it to decline by around 16% this year, followed by a 4.5% average annual growth beyond that. The steep production decline this year is expected mostly because of the asset sales that the company completed last year. However, even after adjusting for divestments, the company’s net hydrocarbon production is expected to grow by just around 2% y-o-y this year, well below the 4.3% CAGR growth it registered between 2012 and 2014.
Below are some key value drivers for Chesapeake that present opportunities for a significant upside or downside to the current Trefis price estimate for the company:
- Crude Oil & NGLs Average Sales Price: Chesapeake's stock price is highly sensitive to crude oil and natural gas liquids prices as the company derives more than 57% of its total value, by our estimates, from the sale of these commodities. We believe that the recent decline in oil prices could sustain for a longer period, amid slower demand growth and the diminishing price-controlling power of the OPEC. According to our estimates, the annual average Brent crude oil price could bottom out around $63 per barrel this year and rise back to around $93 per barrel by 2021. However, if oil prices remain depressed for longer than what we currently expect, and increase only to around $80 per barrel by the end of our forecast period, there could be an almost 10% downside to our current price estimate for Chesapeake.
- Crude Oil & NGLs Net Production: Chesapeake's crude oil and natural gas liquids production has grown sharply from just around 32 million barrels in 2011 to 75 million barrels in 2014, implying a CAGR of almost 33%. We currently forecast Chesapeake's net liquids production to grow to around 88 million barrels by the end of our forecast period. However, if the company is not able to ramp up its crude oil and natural gas liquids production at the projected rate, and it remains relatively flat at 75 million barrels by the end of the Trefis forecast period, there could be a 10% downside to our current price estimate for Chesapeake. On the other hand, if the company is able to grow its net liquids production to about 100 million barrels, there could be a 10% upside to our current price estimate for Chesapeake.
For additional details, select a driver above or select a division from the interactive Trefis split for Chesapeake at the top of the page.
Chesapeake Energy is the 2nd-largest producer of natural gas and the 11th-largest producer of liquids in the United States. The company is also one of the most active drillers of new wells in the U.S. The company's operations are focused on discovering and developing unconventional natural gas and oil fields onshore in the U.S. It owns positions in the Barnett, Fayetteville, Haynesville, Marcellus, and Bossier natural gas shale plays, and in the Eagle Ford, Granite Wash, Niobrara, and various other conventional and unconventional liquid-rich plays across the U.S. The firm has interests in over 45,100 natural gas and crude oil wells that produce approximately 729 thousand barrels of oil equivalent per day.
The natural gas assets that the company built over the years are very lucrative. However, of late, the company's operations have taken a beating due to relatively low natural gas prices. As a result, it has shifted its focus towards crude oil and natural gas liquids, spending heavily on building liquid-rich or oil assets.
Large base of proven reserves
Proved reserves is an extremely critical metric for an oil and gas exploration and production company. It represents the total quantity of technically and economically recoverable oil and gas reserves owned by the company at a given point in time. It directly impacts the company's production growth outlook.
Chesapeake's proved hydrocarbon reserves stood at 2.47 billion barrels of oil equivalent at the end of 2014. The metric decreased by 209 million barrels of oil equivalent, compared to 2013, primarily because of the downward revision of previous reserve estimates and the sale of reserves in place. Despite that, Chesapeake currently holds enough reserves to produce oil and gas for the next 9 years at 2014 production rates.
Chesapeake's net production volume-mix has been improving over the past few years with the proportion of liquids in its total oil equivalent production increasing. Liquids are generally priced higher than dry natural gas due to higher energy density and ease of transportation, among other factors. In addition, severely depressed natural gas prices in the U.S., primarily due to a supply glut, have further eroded the incentive for upstream oil and gas companies to drill for dry gas. In 2014, Chesapeake sold liquids at an average price of over $58 per barrel, while the company realized a price of just around $15 per BOE for natural gas on average.
Therefore, despite lower finding, development, and lifting costs per BOE of natural gas, the production of liquids is still a far more lucrative source of revenue for upstream oil and gas companies in the U.S. The proportion of liquids in Chesapeake's total production volume-mix has improved significantly from just around 16.1% in 2011 to 29.1% in 2014. We expect the company’s sales volume-mix to improve further as it plans to increase its focus on liquids production in the coming years.
Production decline due to asset sales
Chesapeake sold certain assets in the southern Marcellus Shale and a portion of the eastern Utica Shale to a subsidiary of Southwestern Energy Company for aggregate net proceeds of approximately $4.975 billion in 2014. The company sold approximately 413,000 net acres of property and approximately 1,500 wells in northern West Virginia and southern Pennsylvania, of which 435 wells are in the Marcellus or Utica formations, along with related gathering assets and property, plant and equipment.
This is expected to have a significant negative impact on its net liquids production this year. The company expects its net crude oil and natural gas liquids production to be around 63 million barrels this year, down from 75 million barrels last year. The transaction also lowered its long-term growth potential as it resulted in a reduction of its proved undeveloped hydrocarbon reserves by around 105 million barrels or 12% of the starting figure in 2014.
It is estimated that a large part of the world's oil reserves have already been discovered. Recent statistics have indicated that global consumption has been outpacing reserve additions. Peak oil is a commonly used term to describe the point at which world oil output will reach a maximum and decline afterward.
However, many institutions such as the International Energy Agency (IEA) believe that peak oil will not occur for another 25 years at the very least. Many governments across the world are promoting alternative energy measures to ensure that the supply and demand of energy will be met at all times to come.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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