Major Chesapeake Announcement: Shifting from Dry to Wet Gas

stop pressChesapeake Energy today made a major announcement about a change in their investment and drilling strategy for 2012: they will reduce drilling in “dry” natural gas areas by 50 percent for 2012—to 24 rigs by the end of June from the currently operated 47 rigs. Chesapeake operated 75 dry gas rigs in 2011, so the new level is a 67 percent reduction from last year. Chesapeake will also spend some 70 percent less of their capital budget on dry gas drilling in 2012, down to $0.9 billion (from $3.1 billion in 2011). It’s the lowest capital expenditure they’ve made on drilling in dry gas areas since 2005.

By the end of June, Chesapeake says they will be operating only 12 rigs in the dry gas areas of the Marcellus Shale.

Chesapeake is also curtailing (shutting down) production of 0.5 billion cubic feet (bcf) of natural gas per day, which represents 9 percent of U.S. natural gas production. They’re threatening to curtail as much as 1 bcf “if conditions warrant,” which would be 18 percent of national production.

Why the change in plan for 2012? Chesapeake will move their money and drilling activities to those geographies where there’s natural gas liquids, which pay a lot more right now than plain old methane, or dry natural gas.

What does it mean for landowners? Those who live in the dry areas of the Marcellus and Utica Shales, like northeastern and central PA, can expect a noticeable slowdown in new Chesapeake drilling. Those landowners in the liquids-rich areas of the shale plays, like western PA and eastern Ohio, can expect more drilling activity from Chesapeake.

No doubt Chesapeake hopes that by reducing natural gas production it will spur natural gas prices, at historic 10-year lows, to start increasing again.

From the Chesapeake press release:

Chesapeake Energy Corporation today provided an update on additional steps it is taking to continue creating shareholder value in response to the lowest natural gas prices in the past 10 years.

First, Chesapeake plans to further reduce its operated dry gas drilling activity by 50% to approximately 24 rigs by the 2012 second quarter from 47 dry gas rigs currently in use and by 67% from an average of approximately 75 dry gas rigs used during 2011. Chesapeake’s operated dry gas drilling capital expenditures in 2012, net of drilling carries, are expected to decrease to $0.9 billion, a decrease of approximately 70% from similar expenditures of $3.1 billion in 2011. This anticipated level of dry gas drilling capital expenditures is the company’s lowest since 2005. Specifically, during the 2012 second quarter, Chesapeake plans to have reduced its drilling activity in both the Haynesville and Barnett shales to six operated rigs each and to 12 operated rigs in the dry gas area of the Marcellus Shale in northeastern Pennsylvania.

Second, the company plans to immediately curtail approximately 0.5 billion cubic feet (bcf) per day, or 8%, of its current operated gross gas production of 6.3 bcf per day, which is about 9% of the nation’s natural gas production. If conditions warrant, the company is prepared to double this production curtailment to as much as 1.0 bcf per day. In addition, wherever possible, Chesapeake plans to defer completions of dry gas wells that have been drilled but not yet completed, and also plans to defer pipeline connections of dry gas wells that have already been completed.

As a result of lower drilling and completion activity and production curtailments in the Haynesville and Barnett shales, Chesapeake projects that its combined gross operated gas production in these plays will decline during 2012. Because the Haynesville and Barnett shales have accounted for virtually all of the nation’s approximate 14 bcf per day of gas production growth during the past five years, lower production in these two plays will likely lead to flat or lower total natural gas production in the U.S. in 2012.

Third, the company intends to reallocate the capital savings from reduced dry gas drilling, well completion and pipeline connection activities to its liquids-rich plays that offer superior returns in the current strong liquids price environment. This reallocation will result in increased expenditures in certain of Chesapeake’s liquids-rich plays, including the Eagle Ford Shale, Utica Shale, Mississippi Lime, Granite Wash, Cleveland, Tonkawa, Niobrara, Bone Spring, Avalon, Wolfcamp, and Wolfberry. The company estimates that approximately 85% of its 2012 total net operated drilling capital expenditures will be invested in its liquids-rich plays.

Fourth, Chesapeake plans to further reduce its undeveloped leasehold expenditures, the majority of which have been focused on liquids-rich plays during the past three years. The company is now targeting to invest approximately $1.4 billion in undeveloped leasehold expenditures in 2012 (net of joint venture partner reimbursements), of which approximately 90% will target liquids-rich plays and 100% will be in plays where the company is already active. This compares to undeveloped leasehold expenditures, net of joint venture partner reimbursements, of approximately $3.4 billion and $5.8 billion in 2011 and 2010, respectively.

Aubrey K. McClendon, Chesapeake’s Chief Executive Officer, commented, “An exceptionally mild winter to date has pressured U.S. natural gas prices to levels below our prior expectations and below levels that are economically attractive for developing dry gas plays in the U.S., shale or otherwise. Having led the industry in natural gas production growth over the past 10 and five years, we recognize the need to demonstrate leadership and take action now in order to protect value for our shareholders. During the past five years, our gross operated natural gas production has increased from approximately 2.1 bcf per day to 6.3 bcf per day currently, and accounted for approximately 30% of the nation’s total growth in natural gas production.

“In addition, we have elected to further increase the percentage of our total net operated drilling capital expenditures allocated to liquids-rich plays to approximately 85% in order to capture returns that are currently far superior to dry gas plays. We have committed to cut our dry gas drilling to bare minimum levels that are likely to be maintained until expected drilling economics on dry gas plays return to levels competitive with expected returns in Chesapeake’s lineup of liquids-rich plays, which we believe is the best in the industry. As in previous natural gas pricing downturns, Chesapeake is promptly responding to rapidly changing market conditions, and we hope today’s announcement helps disprove the view held by some industry observers that producers fail to act rationally in times of unusually low natural gas prices.

“Furthermore, we are very pleased that our strategic decisions over the past four years have created the opportunity and flexibility for Chesapeake to shift its focus from dry gas plays to liquids-rich plays. Our liquids production has increased from an average of approximately 32,000 barrels (bbls) per day in 2009 to current production of almost 110,000 bbls per day. This performance is the second-best U.S. liquids growth rate in the industry, both on an absolute and a relative basis. As a result, we anticipate that more than 50% of Chesapeake’s 2012 revenue will come from its oil and natural gas liquids production, based on current NYMEX strip prices and Chesapeake’s current hedging positions.

“Finally, we remain on track to meet our debt reduction target of $9.5 billion by year-end 2012 and to increase our liquids production to more than 250,000 bbls per day by 2015, which should represent one of the industry’s best liquids production growth stories during the next four years. We have also captured the nation’s best natural gas resource base, which will become increasingly valuable in the years ahead as demand initiatives in the power generation, transportation, industrial and export sectors gain further traction and enable consumers to more completely embrace natural gas as a clean, affordable, abundant, American resource to fuel an increasing portion of their energy futures.”*

*Chesapeake Energy (Jan 23, 2012) – Chesapeake Energy Corporation Updates Its 2012 Operating Plan in Response to Low Natural Gas Prices

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