Higher Gas Prices, NGL Production Drive Chesapeake Energy’s Earnings

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Chesapeake Energy (NYSE:CHK) reported a strong set of Q1 2014 numbers on May 7, beating market expectations on both revenues and earnings. The company’s results were driven by higher production volumes, better natural gas price realizations and lower production expenses.  While quarterly production revenues were up by around 21% year-over-year to $1.76 billion, adjusted net income nearly doubled to $456 million. [1] In this note, we take a look at some of the key drivers behind the company’s earnings.

See our complete analysis for Chesapeake Energy here

We have revised our price estimate for Chesapeake Energy to about $28 to account for the improved production guidance and outlook. Our price estimate is about in line with the current market price.

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Natural Gas Liquids Drive Production Growth

Chesapeake’s overall quarterly production grew by 2% year-over-year to around 60.8 million barrels of oil equivalent (boe). However, adjusting for recent asset sales, production rose by an encouraging 11%. Oil production improved by around 6%, although natural gas production saw a slight decline. However, natural gas liquids (NGL) remained the key growth driver for the quarter, with production rising by about 55% year-over year to 7.6 million barrels. This growth has come from strong production in the Utica and Southern Marcellus regions. Infrastructure has for long proved a bottleneck in the Utica shale, and the commencement of shipments on pipelines such as the ATEX  pipeline (which provides connectivity to the Gulf) during the quarter has provided much-needed takeaway capacity from the shale. Chesapeake’s output from the Utica shale increased by around 422% year-over-year, and natural gas liquids production has accounted for roughly 30% of its Utica volumes. Chesapeake also raised its 2014 total production growth outlook to 9–12%, up from a previous estimate of 8-10%, on the back of better natural gas liquids volumes (see A Look At Chesapeake’s NGL Production Guidance).

Better Price Realizations For Natural Gas

Chesapeake’s natural gas price realizations rose to around $3.27 per thousand cubic feet (mcf) from around $2.13 per mcf during the same quarter last year. Natural gas prices in the United States soared by over 30% for the quarter (year-over-year), on the back of severe winter weather conditions in the Northern and Eastern parts of the country, which brought about higher heating related demand. NYMEX prices were largely above $4.50 per MMBtu (the NYMEX price is different from Chesapeake’s realized price due to geographic differentials related to transportation and other factors). However, Chesapeake’s price realizations have grown faster than the broader market since the company benefited from some firm gas transportation contracts that it held on the Spectra pipeline in the North East. ((Chesapeake Energy Q1 2014 Earnings Conference Call, Seeking Alpha, May 2014)) The benchmark gas price on this pipeline, which carried some of  Chesapeake’s output from the North Marcellus, is based on the TETCO-M3 hub, which has been seeing a significant premium over NYMEX prices. This was partly responsible for the better price realizations for Chesapeake through Q1.

Cost And Cash Flow Related Improvements

Chesapeake’s production-related costs declined by about 8% to around $4.73 per boe as a result of higher volumes, which reduced per unit costs. General and administrative expenses per unit of production fell by 26% to $1.09 per boe. Operating expenses aside, Chesapeake has also been making notable progress in curtailing its capital expenditures, despite the fact that it has been raising its production targets.  Key drivers of the lower capex include better allocation of capital (a large portion of capital is being allocated to the company’s most productive plays) as well as improved drilling and completion efficiencies (by using techniques such as pad drilling). This is likely to be the first year since 2001 in which Chesapeake’s operating cash flows – projected at $5.8 billion to $6 billion – will exceed its capital expenditures ($5.2 to $5.6 billion). [2]

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Notes:
  1. Q1 2014 Earnings Press Release, Chesapeake Energy, May 2014 []
  2. Chesapeake Energy Investor Presentation, Chesapeake Energy, May 2014 []