Chesapeake 1Q 2015 Preview: Lower Oil Prices, Net Production To Weigh On Earnings

Chesapeake Energy (NYSE:CHK) is scheduled to announce its 2015 first-quarter earnings on May 6. We expect lower price realizations to weigh significantly on the company’s financial results. Chesapeake’s net hydrocarbon production is comprised of 70% natural gas and 30% liquids (crude oil and natural gas liquids). Benchmark crude oil prices have fallen sharply since June of last year on rising supplies amid slower demand growth. The average WTI crude oil spot price declined by more than $50 per barrel or 50% year-on-year during the first quarter. In addition, the average Henry Hub natural gas spot price also declined by $2.31 or 44.3% y-o-y during the quarter. Apart from lower price realizations, we expect Chesapeake’s first-quarter earnings to also fall as a result of lower net production, primarily driven by recent divestitures, curtailments, and higher project downtime. However, hedging gains and productivity improvements are expected to partially offset the impact of lower benchmark prices and net production on the company’s overall performance.

Chesapeake is the 2nd-largest producer of natural gas and the 11th-largest producer of liquids (crude oil and natural gas liquids) in the United States. The company’s operations are focused on discovering and developing unconventional natural gas and crude 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 (MBOED), net to Chesapeake. At the end of 2014, Chesapeake’s proved hydrocarbon reserves stood at almost 2.47 billion barrels of oil equivalent, with 75.5% of these reserves categorized as proved developed. We currently have a $15 per share price estimate for Chesapeake, which is around 10% below its current market price. ^[1]

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Lower Net Production

Chesapeake’s net hydrocarbon production is expected to decline both sequentially and year-on-year during the first quarter. This is primarily because of the impact of recent divestitures completed by the company to enhance its liquidity and reduce the debt burden. Last year, 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. 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 were in the Marcellus or Utica formations, along with related gathering assets and property, plant, and equipment. This is expected to reduce the company’s net oil and gas production by around 57 MBOED sequentially. ^[2]

In addition, Chesapeake also began the curtailment of its net operated production in the Marcellus shale during the fourth quarter last year, primarily because of low in-basin field prices. This lowered its net hydrocarbon production by around 15 MBOED in 4Q 2014 and is expected to have continued during the first quarter as well. Apart from this, higher project downtime is also expected to bring down the company’s net hydrocarbon production in 1Q 2015. For the full year, Chesapeake currently expects its net production, adjusted for the impact of recent divestitures, to grow by around 1-3% despite the sharp cut in drilling activity, primarily because of drilling efficiency improvements implemented over the last couple of years and the expected deflation in service costs during the second half of the year. ^[3]

Hedging Gains

Chesapeake hedges a significant portion of its net production to reduce the impact of the volatility in commodity prices on its financial performance. In its latest annual SEC filing, the company noted that it has downside price protection on approximately 43% of its projected net crude oil and natural gas production for 2015 at an average price of $93.39 per barrel of crude oil and $4.21 per thousand cubic feet (mcf) of natural gas. This basically means that the overall impact of the recent decline in benchmark commodity prices on Chesapeake’s financial performance will be mitigated to a certain extent. As the company delivers the quantity of oil and gas locked in hedging contracts, it will book a gain representing the difference between its actual revenue and the estimated revenue at prevailing commodity prices, net of transaction costs. This will partially offset the impact of softer benchmark commodity prices and lower net production on its overall performance. ^[1]

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1. Chesapeake 2014 10-K, sec.gov [↩] [↩]
2. Chesapeake Q4 2014 Earnings Call Transcript, chk.com [↩]
3. Chesapeake Howard Weil Conference Presentation, chk.com [↩]