Tuesday, September 23, 2008

Low Natural Gas Prices for a While?

I was reading Chesapeake Energy's recent operational and financial update and was a little taken aback by some of what I read. The gist of the release is that Chesapeake is going to reduce its drilling capital budget by $3.2 billion through 2010. This is big. It comes as a result of the suddenly depressed price of natural gas, and Chesapeake probably won't be the last company to issue a statement that they are cutting back on near future drilling costs.

To me this indicates that the gas companies are actually a little scared about the price of natural gas going forward. All of this talk about over supply and lessened demand in the market might be more real than previously anticipated. In reading Chesapeake's statement, the company almost made it sound like getting natural gas into cars will be a necessity rather than a bonus.

Chesapeake is under pressure from Wall Street to reduce its debt to stabilize its stock price. To say that the company is going to spend billions on drilling when the price of natural gas is almost too low to make a profit on some of the wells puts Chesapeake in a bad position. This is going to be a tricky play for Chesapeake given the fact that the company has more than a half million acres (gross) of leased property that it has to drill to hold the leases by three to five years from now. It will make Wall Street happy in the short term, but it is still an open question for the long term.

Tuesday, September 16, 2008

Interesting Morningstar Article

In my previous post, I referenced an article on Morningstar.com (link to article) that offered some interesting insight and analysis of the perceived upcoming oversupply in the natural gas industry. I recommend reading the article (it's not too long) because it makes some great points about the gas industry and the Haynesville Play.

Perhaps the most interesting section is the discussion of Haynesville. Because there has been such a land rush in the Haynesville Play, the gas companies are under huge pressure to drill. They amount of land leased is tremendous - Chesapeake has leased over 550,000 acres (not counting what it has put in joint ventures to calculate its "net leased" land) - and most of the leases are for three years (some are three with a two year option). This creates a need to drill and produce on the land to be able to hold the lease before it expires. They are hell-bent to get the leases HBP (held by production) so they can suck it dry over time.

This rush to drill by multiple companies has caused huge strains on the drilling infrastructure - drilling rigs, parts and supplies, pipeline capacity and personnel. There is only so much infrastructure out there and if the production out of Haynesville is going to be as big as expected, it's going to be stuck in the ground without huge expansion of the above ground resources. Don't forget that there are other plays demanding these resources, including Barnett, Marcellus, Fayetteville and Woodford. Chesapeake is on record having said that they have been building new rigs over the past couple of years for this very reason, but what about the other guys?

Another consideration related to the constrained resources is the monetary capital required to do all of this drilling in a short period of time. The exploration companies have spent the summer selling equity, raising debt, selling assets and entering into joint venture agreements to the point that they are maxing out their availability. Wall Street sees this and is spooked. In its infinite short-sightedness, Wall Street is punishing the natural gas companies badly. All of those investors who bought new shares over the past few months have to be sweating as they watch their investments sink (in the short term, at least).

On top of these constraints, the gas companies watched the price of natural gas plummet over the past two months. The gas futures price today ($7.20 at this moment) is approximately half of what it was in mid-July. At some point expensive horizontal drilling becomes uneconomical if the sales price is too low. Let's hope smart companies locked in future gas deliveries when the prices were in the double digits.

It's going to be an interesting time in the Haynesville Play for the next year (actually next three years) to see how the exploration companies behave. With the various constraints I've mentioned above, they are in a box right now, and it seems the only way out is to "drill, baby, drill!"

Monday, September 15, 2008

Is There Something to the Oversupply Question?

As I was watching a TV commercial for Chesapeake Energy (for the company itself, not one of the many initiatives they push), I was struck with the thought that maybe there is something to the question of whether or not we are going to be facing a natural gas glut in this country for the near future. I'm seeing lots of articles stating this (see recent Morningstar article), but so much of mainstream business media plays a sad "me too" game that it's hard to know when we are reading real insight or something that is being rehashed for a different publication.

The stock prices of the major gas producers certainly indicate that many investors believe there is going to be an oversupply, but it is very hard to tell where the Smart Money and the Dumb Money diverge. Wall Street is obsessed with short term results at the expense of long term truths, which causes lots of unnecessary volatility in most stocks (which is in turn good for the traders). But the gas producers are getting hammered worse on a percentage basis than the decline in price of natural gas. Is that where the Smart Money comes in? Is the truth that there are oversupply issues on the horizon? If the price of natural gas goes down by much more, many onshore drilling projects will not be economically feasible. But sometimes it is easy to confuse the real Smart Money with the useless Overpaid Money that just acts on rumor and trends. There are way too many "Hedge Fund Managers" out there getting paid a lot to follow the herd.

But I keep scratching my head about Chesapeake. Are these media ads an act of ego (as I originally believed), a good strategic move to expand markets for natural gas to other uses and new markets (as I have come to believe) or an act of desperation by companies whose very existence is inextricably linked to natural gas and suddenly see a bleak future (I'm not there yet, but I'm starting to worry)?

Ultimately, I still think the fundamentals for natural gas are strong and the market is overreacting to short term trends. It's hard to hold tight when the ship looks like its sinking, but that's where the Smart Money makes a killing.

Thursday, September 4, 2008

Chesapeake: The New King of All Media

I was a little surprised the other day to see a two page spread in the Wall Street Journal advertising compressed natural gas for cars (CNG). Glancing over the huge ad, I was not at all surprised to see the Chesapeake Energy logo in the lower left hand corner of the ad. With all of the advertising campaigns Chesapeake has sponsored, I'm beginning to wonder if Chesapeake is an exploration and drilling company or a media and advocacy company.

Chesapeake is behind the new campaign called CNG NOW (http://www.cngnow.com/). The site is also linked to the Pickens Plan, which promotes natural gas automobiles. The company also visibly backs The American Clean Skies Foundation and Shale.TV, along with a few other geographically specific advocacy programs. Chesapeake is positioning itself as the #1 gas producer in the US, so it makes sense that it takes the lead on media initiatives that promote natural gas.

It is good for the natural gas industry to position itself as the cleanest and least expensive fossil fuel (along with being a "home grown" product), especially given all of the advertising coal is doing ("clean coal" anybody?), but I wonder where the line is between promoting your product and ego. Ultimately, promoting natural gas use both here and as an export product is beneficial to the owners in the Haynesville Play, but I sometimes get a little uneasy with some of Chesapeake's techniques.

Tuesday, September 2, 2008

BP-Chesapeake Deal in Arkansas

A month and a half after Chesapeake sold all of its rights in the Woodford Shale to BP, it has inked a deal to sell a 25% interest in its Fayetteville Shale to BP for a total of $1.9 billion ($1.1 billion upfront, $800K for completion costs in 2008 and 2009) (Forbes article). This continues a string of deals by Chesapeake (remember huge Plains Exploration deal in the Haynesville Play?) that will likely continue until they sign a deal for their interest in the Marcellus Shale.

Chesapeake's strategy is hitting full stride. The company has decided to focus on the Barnett, Haynesville, Fayetteville and Marcellus Shales and the strategy is to get into the play fast and hard to tie up as much acreage as possible and then get a big player as a partner to provide additional funding and support to drill and produce on the properties. This strategy is necessary because Chesapeake has taken on a large amount of debt in its aggressive activities. I'm sure they'd rather go it alone than sell of a portion of their stake, but since the company has taken down so much land, it will require huge amounts of capital to do the drilling. Chesapeake doesn't have enough debt capacity, so they have to set up these joint ventures. It is rather ingenious because they are making a big profit on their early land deals and then share the burden of the risk for the capital-intensive drilling component.