How Chesapeake’s Priorities Are Shifting As Natural Gas Prices Remain Low

As the price of natural gas declines, Chesapeake Energy (NYSE:CHK) has been concentrating on improving the efficiency of its operations. With the Henry Hub benchmark of natural gas falling from a February high of nearly $6.5 per 10,000 Million British Thermal Units(MMBtu) to its current level of around $3.8/MMBtu, Chesapeake’s top line has been shrinking. ((NYMEX Natural Gas Futures for December delivery, WTRG, October 2014)) Consequently, the company has been making significant efforts towards steady improvements in its operations to maintain profitability. To demonstrate the shift towards operational discipline, we take a closer look at two of the company’s top assets, the Haynesville and Eagle Ford shales, which together contribute to nearly a quarter of the company’s production.

See our complete analysis for Chesapeake Energy here

We have a $26 price estimate for Chesapeake Energy, which is about 25% above the current market price. We will be updating our price estimate for Chesapeake after the earnings release.

Reduced Number of Wells

Chesapeake Energy has showed a significant improvement in the present value of its oil and gas revenues. Compared to only 46% in 2012, about 85% of its wells were profitable in the first quarter of fiscal 2014. The improvement, due in part to reduced costs, but also to a shift from less profitable wells to more lucrative opportunities. The company has also lowered the number of completed wells: in the first quarter of 2014, it completed 234 wells compared to 274 wells in the same quarter last year and 1,388 during 2013. The company is targeting 1,200 completed wells this year. As part of its ongoing cost reduction efforts, the company has brought up to date its asset-divestment program, which includes the sale of non-core assets in Southwestern Oklahoma, East Texas, and South Texas. But apart from the sale of assets, Chesapeake Energy has also been shifting its operations towards more profitable assets.

Haynesville

The Haynesville shale, a popular name for a rock formation that underlies large parts of southwestern Arkansas, northwest Louisiana, and East Texasregion, is less profitable for the company than other regions, as it primarily produces natural gas. In the early months of 2014, the recovery of natural gas prices made this region’s output more profitable, but over the long run, the company is expected to cut its production in this region. In the first quarter alone, Chesapeake cut down production in the region by 41% to 495 million cubic feet of natural gas equivalent, year over year. The following chart from a presentation made by the company demonstrates how Haynesville is less profitable than other regions:

Source: Chesapeake IR Presentation

This chart compares the average cost of wells in the Haynesville shale and Eagle Ford shale. Evidently, Eagle Ford is much cheaper to operate than Haynesville, but when we factor in the fact that Eagle Ford has bigger part in oil operations that are likely to be profitable in the long term, the contrast is made even starker. A lot of other oil and gas producers have backed out of Haynesville: according to Energy Administration Information, the number of rigs in operations in Haynesville has dropped to 50 in 2014 from around 250 in 2010. Natural gas production has also declined over the same period.

Eagle Ford

The Eagle Ford shale has been gaining in popularity in recent years with other producers, such as Devon Energy, also entering the location. It is estimated that production in the Eagle Ford shale can rise by as much 40% by 2020, from the current level of around 1.4 million barrels a day. ^[1] Chesapeake’s production at the Eagle Ford shale comprises of around two-thirds oil and one-fourth natural gas, with natural gas liquids making up the rest. Even though, Chesapeake has been cutting down on the number of wells in operation, the number of operating wells in Eagle Ford has increased by nearly 50% compared to last year. Furthermore, net oil production has grown by as much as 17% over the same period. Adjusted for asset sales, the company’s production in the region has grown by 26% over the last year in the region. The company has planned to commit nearly 40% of its total Capital Expenditures(CapEx) towards expanding operations in the region. In comparison, the company only plans to allocated 8% of its CapEx to Haynesville.

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1. Eagle Ford production likely to double, consultancy predicts, BizJournal, June 2014 [↩]