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Investment Overview for Chesapeake (NYSE:CHK)
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Chesapeake Energy is the second largest producer of natural gas and the most active driller 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 44,000 producing natural gas and oil wells that produce over 2 billion cubic feet equivalent per day, 93% of which is natural gas.
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 low natural gas prices. As a result, it has shifted its focus toward a balanced mix of gas and oil, spending heavily on building liquid-rich or oil assets. Meanwhile, the company has been grappling with liquidity issues. In 2012, the firm divested around $11 billion in assets and intends to divest a significant portion in 2013 as well.
The company has also vertically integrated its operations and owns substantial midstream, compression, drilling and oilfield service assets.
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High margins for natural gas and oil divisions
Prior to the recent economic downturn, which impacted EBITDA margins across all divisions, natural gas and oil EBITDA margins averaged around 85%. Margins declined to 76% in 2011 as natural gas priced dropped substantially. However, the division is so valuable because even during times of near-record low prices it was able to maintain margins in excess of 75%. This is because the low prices were offset by higher volumes.
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Increasing costs associated with upstream / downstream activities
The costs associated with constructing new oil and gas upstream facilities have reached a new record high, according an analysis by Cambridge Energy Research Associates (CERA). According to the analysis, costs related to the extraction of oil & gas have doubled since 2005.
This has been primarily due to several reasons:
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Increasing commodity prices:
Prices of key inputs such as fuel, chemicals and steel have risen as demand grew in emerging markets. Some refineries typically use 5-7% of their feedstock as fuel to run refineries. Firms are increasing their focus on energy efficiency to drive this down
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Complexity of projects:
Various oil companies have embarked on different projects to extract oil such as deepwater, GTL and oil sands. This has led to longer development timelines which have in turn resulted in higher costs.
Coal as an alternative to gas
Coal and natural gas are the closest substitutes as a fuel for power generation. Surges in coal demand are generally associated with a drop in gas demand and vice-versa. Recently, the attractiveness of gas in U.S. power generation due to low prices has impacted coal demand. However, when gas prices eventually recover, coal demand will likely increase and cannibalize gas demand.
Trefis Forecast Rationale for Oil & NGL Net Production
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This refers to the quantity of crude oil produced by Chesapeake in millions of barrels(MMbbl).
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Chesapeake's ${forecast} increased from around 11 mmbbls to around 48.88 mmbls in 2012, as the company expanded its oil producing capabilities to support the growing demand for oil. In the near term, we expect the company to increase liquids production by between 5-10% per year. In the long term, we expect the growth will moderate with ${forecast} reaching around 90 mmbbls by the end of the Trefis forecast period.
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Trefis considered the following factors for its forecast.
Supporting
- Heavy spending on liquid-rich plays
- Chesapeake's capital expenditures have seen a drastic shift of late and it expects to spend nearly 85% of its capital budget on building liquid-rich plays.
- As the natural gas prices have been low recently, the company's operations were severely impacted because of its reliance on natural gas. As a result, the company has shifted its focus to a more balanced mix of liquid-rich plays and dry gas plays, in turn building liquid-rich plays much more rapidly then before.
- Discovery of oil reserves
- As of 2011 global proven oil reserves stood at 1.65 trillion barrels, an increase of nearly 50% from the levels in 2000. As major oil companies discover more oil reserves both onshore and offshore, oil production is likely ot see strong growth.
- Growth in deepwater exploration and production
- Modern technology has made it easier for companies to explore previously unreachable areas. Petroleum can often be found in subsalt reserves, which are thousands of meters below layers of sand and rocks.
- The discovery of the Tupi field in Brazil in 2007 is considered to be the largest in the Americas since 1970. Estimated recoverable reserves stand at 5-8 billion barrels. It is expected to increase Brazil’s recoverable reserves of crude oil by 50%. Similar discoveries could lead to substantial growth in production.
Mitigating
- Increasing cost of production can reduce economic viability of many oil fields
- Oil production involves heavy upfront costs that are associated with exploring and developing oil fields. This is in addition to the lifting costs that are incurred.
- While technological improvements have made things easier and oil discoveries cheaper, costs nonetheless have been going up sharply in recent years.
- Increasing adoption of alternative fuels
- Alternative fuels, while growing rapidly, still account for a small percentage of total fuel consumption. As alternatives become more economically viable and governments implement stricter emissions standards (thus making fossil fuel consumption costlier) we expect greater adoption of alternatives. This will impact oil production.
Back to Company OverviewHow 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:
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