Chesapeake Energy slashes drilling budget

Chesapeake Energy is slashing its drilling capital expenditure budget by $3.2 billion, or 17%, for the second half of 2008 through 2010.

Sam Fletcher
Senior Writer

HOUSTON, Sept. 25 -- Chesapeake Energy Corp., the second-largest independent and third-largest overall producer of natural gas in the US, is slashing its drilling capital expenditure budget by $3.2 billion, or 17%, for the second half of 2008 through 2010.

Company officials blamed a 50% drop in gas prices since June and the possibility of an emerging gas surplus in advance of increased demand from the US transportation sector.

"Expect other firms to follow Chesapeake's lead and lay down rigs as well," said analysts in the Houston office of Raymond James & Associates Inc. "We continue to see reduced drilling activity (lower rig count) as necessary to balance the natural gas market. Still, this may lead to the decline in activity about a quarter earlier than we anticipated."

Chesapeake's budget cut includes $800 million attributable to the drilling capex carry in the firm's recently formed Fayetteville shale joint venture with BP America Inc. Chesapeake closed that 25% joint venture with BP PLC on Sept. 19 for $1.1 billion cash plus $800 million funding by BP of Chesapeake's 75% share of drilling and completion expenses in that program through 2009.

The budget reduction also includes $500 million for the anticipated drilling capex carry in a Marcellus shale 25% joint venture that the company expects to complete by the end of this year. However, the bulk of the cut, $1.9 billion, represents a rollback in drilling activity, reducing its current count of 157 operated rigs to 140 rigs by yearend. Chesapeake then expects to keep its rig count relatively flat in 2009-10.

"This should not be considered good news for domestic land drillers given that Chesapeake does not typically lay down its own rigs," Raymond James analysts warned. Nomac Drilling Corp. in Oklahoma City belongs to Chesapeake Energy.

Moreover, Raymond James noted, "This does not seem to be a fundamental savior for gas prices since Chesapeake still plans to increase its production by 16% year-over-year despite 11% less rigs."

Chesapeake lowered its production growth forecasts to 16%/year for 2009-10 from 19% previously. The company said its production growth will remain near the top of its large-cap peer group because of continued strong drilling results from its shale plays. In September, Chesapeake completed three horizontal Haynesville shale wells with average initial production exceeding 10 MMcfd of gas equivalent per well, bringing its total horizontal Haynesville shale wells on production to 14.

Analysts said, "Companies tied to the production enhancement side of the business may be a bit better off due to the service intensive nature of the new shale plays, but with numerous wells expected to be shut-in and capacity coming online, 2009 is shaping up to be an ugly year in North America."

Chesapeake temporarily is curtailing part of its unhedged natural gas production in the Midcontinent region due to "unusually weak wellhead prices substantially below industry breakeven costs." It has shut in 100 MMcfd of net gas production (125-150 MMcfd gross), representing 4% of its current net production of 2.3 bcfd of gas equivalent (92% gas). Officials said they will restore this production when the market recovers from recently depressed wellhead price levels of $3-5/Mcf.

The company reduced its 2008 production growth estimate to 18% from 21% to account for production curtailment, sale of 45 MMcfd of gas equivalent production associated with its joint venture with BP, the anticipated sale of 60 MMcfd of gas equivalent in the fourth quarter associated with Chesapeake's fourth volumetric production payment, and shut-ins of onshore production due to gas processing plant limitations resulting from Hurricane Ike.

Chesapeake recently resumed plans to sell a minority interest in its midstream natural gas business to institutional investors, with the projected $1 billion proceeds to fund a portion of the costs associated with building the midstream infrastructure in various shale plays, primarily in the Haynesville shale. As part of that move, Chesapeake is transferring all of its midstream natural gas assets outside of Appalachia, primarily of gas gathering systems and processing facilities, into new partnership entities managed by Chesapeake Midstream Partners LP.

Through asset sales and budget reductions, Chesapeake expects to generate $2 billion excess cash in 2009-10 that will be directed primarily to debt reduction.

Chesapeake has focused on exploratory and developmental drilling and corporate and property acquisitions in the Midcontinent, Fort Worth Barnett shale, Fayetteville shale, Haynesville shale, Permian basin, Delaware basin, South Texas, the Texas Gulf Coast, the Ark-La-Tex region, and the Appalachian basin.

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