CHESAPEAKE ENERGY CORP CHK S
November 15, 2009 - 10:29pm EST by
utah1009
2009 2010
Price: 25.03 EPS NA NA
Shares Out. (in M): 626 P/E NA NA
Market Cap (in $M): 16,000 P/FCF NA NA
Net Debt (in $M): 12,480 EBIT 0 0
TEV ($): 28,480 TEV/EBIT NA NA
Borrow Cost: NA

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Description

Chesapeake is a company that's easy to hate.  A messy balance sheet, an awful management team, and the street loves it.  This recommendation has two components.  First is a macro call and my opinion that we will see a stunning crash in gas prices in the next two years.  Second is that CHK is not only a company completely void of any serious long-term investment merits, but will also be adversely affected worse than most E&P's if gas goes lower.

Nat Gas: A History

I realize the inherent risk in recommending a crash in gas prices have already gone from $13 to $5, but that's what I think is going to happen.  Here's a very brief history lesson on gas.  For a long time gas production in the US was flat despite more drilling and more spending - we were running to stand still.  In the early 2000's the industry finally figured out how to produce gas from shale through new technologies, primarily horizontal drilling and fracture stimulation.  As more companies got into the shale game, which is unimaginably large, and the techniques were refined, gas production in the US began to increase by 5-10% annually, at an accelerating rate.  People were so euphoric about all the new reserves they forgot that overall, this much gas is bad for business.  So in 2008, prices crashed with the rest of commodities as demand vanished, while investors started to wonder whether the long-term fundamentals, driven by tons of new shale reserves and a weak economy, would keep gas prices low for a long time. 

Now we're at a place where prices are low and people are expecting the Econ 101 reaction from the industry, which is to produce less and watch prices rise.  Many forecasts have been made about this rational expectation, with 2010 estimates ranging from down 3% to down 12%.  Regardless, if there's one thing that almost everyone can agree on is that production needs to decline, otherwise we're in a lot of trouble.  There is almost no debate on this, we are simply producing too much gas right now...heck, we were producing too much gas before the recession when demand was strong.  And almost universally, people are expecting huge production declines in 2010.

Nat Gas: Why 2010 Is Going To Be Ugly

In 2009 people started building models to forecast the supply/demand picture for gas.  Analysts started looking at well decline curves (very steep for shale), rigs employed, initial production (IP) rates, capital spending, etc in order to gauge where there thought supply would bottom.  There are 3 macro models that are notable.  Two are from energy boutique investment banks - Tudor Pickering Holt, and Simmons & Co.  The third model is from none other than Chesapeake, as they are one of the few companies to publicly talk about their own model, and many people seem to look at them for macro insight.  

The TPH model was unveiled to much hullabaloo a few weeks ago, complete with a fancy slide deck and conference call.  They have modeled out about 25 basins from the ground up, forecasting production by using an average well curve and ratcheting the rig count up or down.  Simmons has done something similar, as has Chesapeake I believe.  These models are unstable and reminiscent of CDO models.  I know this because it's easy to build a model for say, the Fayetteville Shale, I've done it myself.  The problem you find is that very small changes in your inputs - days to drill, first year decline, increasing efficiencies - can have game changing effects on the results.  

These models are proving to be incorrect for one basic reason: newer shale wells have very high initial production.  For example, a Haynesville Shale well might produce 5-7x the amount of a Barnett Shale well, therefore cutting the rig count wont matter because most of the incremental production easily offsets the 50% decline in rigs.  Production is declining in certain areas like the Barnett Shale, but new, larger plays like the Haynesville Shale and Marcellus Shale are offsetting the losses.  I say forget the production models, if it's future production data you want, ask and ye shall receive.  Just poll the companies who actually produce gas, and see what they say they're going to do.  I looked at 40 of the largest US gas producers, and what they are telling you is the exact opposite of what analysts and companies are predicting. 

Despite what everyone is forecasting about production being down in 2010, I could only find 7 companies who have either guided lower US gas production or the street expectation is for a production decline.  These 7 companies only represent about 15% of total US production.  Meanwhile, when you look at the 40 largest companies and do a weighted average based on current production, as a whole these firms plan to increase production by 5% next year.  Combined, they make up about 60% of total US production.  This would mean that in order for 2010 production to stay flat, private companies would have to cut production by 5%.  In order to hit TPH's target of down 7%, private companies would have to cut by 22%.  And to hit Chesapeake's target of down 11%, private companies would have to cut by 33%.  Those production declines will never happen, and I expect 2010 will be an historically bad year for nat gas.

 Other than company guidance, why am I so sure that production will remain too high in 2010?  First, capex budgets were already down substantially in 2009, and companies appear very reluctant to cut them further.  They see 2009 as the adjustment year, they're not ready for another year of pain.  Second, the industry has raised billions in fresh capital and has delevered quite a bit, so they've still got money to spend.  Third, it's what managements are paid to do.  These guys' bonuses are mostly based on production growth either directly or through other measures that derive from production such as EBITDA and reserve replacement.  If you're not growing, you're not getting paid...shrinking companies isn't in their DNA (at least not intentionally).  Finally, most companies have hedged 2010 production at decent prices, so they wont necessarily be forced to slash their budgets. 

The fact of the matter is that today's prices are the worst possible place for the industry.  Nat gas is high enough that there's no immediate need to hit the panic button and firms can increase production in the aggregate (for now).  Unfortunately, prices are also low enough that very few firms are creating any value, and living within cash flow is leading to weak growth.  I was reassured by my take on all this when Ken Peak, the CEO of value junkie favorite Contango Oil & Gas, and probably the smartest CEO in the energy business, had this to say:

"Industry supply trends together with my gleanings from a number of recent industry conference calls lead me to believe the industry may be on its way to drilling gas prices back to the $2.00 to $4.00/Mcf price level. Even though demand for natural gas is likely increasing, supply from the onshore lower 48 since November 2008 has been basically flat despite an approximate 50% drop in rigs drilling for natural gas. In essence the increase in production from shale wells has overcome ongoing industry-wide geologic decline while drilling significantly fewer wells. Thus, a second round of gas price declines may be in front of us." - Ken Peak, 11/9/09, first quarter press release

At some point all this has got to stop.  The only way to get aggregate production to a stable level that allows prices to rise is to physically cut these companies off from their sources of capital.  And the banks/shareholders are complicit until they're forced to stop.  The only way I see this happening is if there are some blowups (or near-deaths) in the industry and people become much more suspicious about giving these companies money.  There is going to be an ugly transition in this industry, and as the growth rates and profitability come down they'll bring stock prices with them.  I find it amazing that many E&P's were hitting 52 week highs just 2-3 weeks ago.

Chesapeake: At Best A Stock You Never Want To Own 

1) The historical performance of this company is terrible, but you'd never know it from listening to management.  Aubrey cant open his mouth without talking about "shareholder value creation", although he uses it as nothing more than a hollow catchphrase.  

"This singular focus gives us a chance to be the very best in the industry at one thing, and when you can be the best at one thing you have a chance to create increases in shareholder value year after year." - Aubrey McClendon, 2/25/03, Q4 Conference Call 

"We are now distinctively positioned to continue reaping the rewards from those timely investments, and to continue delivering top-tier shareholder value for years to come." Aubrey McClendon, 2/23/05, Q4 Conference Call 

"I believe you will be very impressed with what we will deliver to you in shareholder value creation in the years to come." - Aubrey McClendon, 10/27/06, Q3 Conference Call 

"We don't believe you can find a better combination of great growth and value in the industry and are excited about the shareholder value creation that has occurred to date." - Aubrey McClendon, 5/2/08, Q1 Conference Call 

 "I believe in what I do for a living; I create value...While this company has had its ups and downs along the way, we have consistently delivered shareholder value over long periods of time and we will continue that in the years ahead...it's there today; you can't see it, but it is there, and it will be recognized over time." - Aubrey McClendon, 6/19/09, Annual Meeting [this one's my favorite] 

If Chesapeake has created so much shareholder value, why do they have negative retained earnings?  Why is the entire book value of this company paid-in-capital?  All of those impairment charges add up...they weren't non-cash when you spent the money.  Why has Chesapeake's stock underperformed other large-cap E&P's by 40%, and larger shale-focused companies by 55% in the last 10 years?  It's actually the worst performing stock over the last 2, 6 and 12 years among its comp group.  Chesapeake trades at the same price today as it did when "Macarena" when the #1 Billboard song (Summer 1996).  Why has the debt-adjusted production and reserves per share declined over time?  This company has done nothing but destroy value, and I believe they will continue on this path indefinitely.

2) Chesapeake is a chronic issuer of new capital, with little to show for it.  In this decade, Chesapeake has sold $10.4 billion in common and preferred stock and raised $12.3 billion in net debt.  The shares outstanding have increased over fourfold, from 150 million to 625 million.  Against this, Chesapeake has returned $600 million to shareholders via dividends and buybacks.  Net capital invested is $23.2 billion.  What has all that money bought?  How about a PV10 of $7.6 billion, $5-12 billion in unproved acreage, and $4 billion in other stuff.  Meanwhile, the company sports an enterprise value of $28.9 billion.

Chesapeake had gone on a company/acreage acquisition binge throughout the early/mid 2000's, constantly outspending cash flow.  Shareholders were getting fed up with the capital raises even then, so around 2006-2007, after the $2.3 billion acquisition of Columbia Natural Resources, the story about the company changed.  Management repeatedly stated that the asset accumulation phase was over, and now was the time to harvest those best-in-class assets and finally watch the per share production/reserve/cash flow metrics take off.

"Nothing else has to work for us. No acquisitions, no stealth plays. We just keep our heads down and keep drilling ahead on the acreage that we own...please recall that now we can deliver all of this value creation without adding debt or increasing our share count." - Aubrey McClendon, 2/15/08, Q4 2007 Conference Call

Net increase in debt since that quote: $2 billion.  Net share count increase: 150 million, or 31.5%.  This management simply does not know how to run a business without continually diluting shareholders. 

3) Aubrey McClendon is a terrible CEO and is single-handedly responsible for Chesapeake's poor performance.  He took Chesapeake to the brink of ruin in the late 1990's by levering up the company to go after the Austin Chalk, then getting killed when the Chalk wasn't that good and gas prices plummeted.  Last year he almost blew it up again by levering up to buy billions of new leases right before gas prices crashed.  And in an event that redefined schadenfreude, Aubrey almost became a household name in 2008 from getting the mother of all margin calls, losing $2 billion and single handedly tanking the stock of his company.  He has proven time and time again that he does not understand the concepts of value creation or risk management.  The third quarter conference call was particularly enlightening, it gives you a good flavor for what he's like.  Among the things he discussed: 

  • 2010/2011 reserve guidance assumes that current reserves are merely "temporarily" depressed
  • 2010/2011 reserve guidance was based on what they thought prices will be
    • Btw, nobody else in the industry gives reserve guidance, let alone on forecasted prices
  • They consider not paying down debt deleveraging as long as reserves are growing
    • Note that they ignore the value of those reserves
  • Aubrey tried his hardest to publicly humiliate every E&P company for not having the same technical capabilities and skill at identifying and acquiring land
  • Management believes that they themselves are a competitive advantage
  • Aubrey stated that his hedging "creates" shareholder value whereas competitors' hedging "limits" shareholder value
  • Despite having only 20% of 2010 gas hedged, Aubrey stated that it "was not possible" that 2010 FCF could be negative

He's notorious for being one of the most promotional CEO's in the industry.  I would encourage people to read his opening remarks from the last couple years' conference calls, it's nothing but pure bewilderment over the "value creation" that goes on at the company.

4) Chesapeake is one of the least hedged companies in the industry at 22% in 2010...heck, management seems downright proud of this.  And with the knockouts and 3-ways they're at risk of losing 50% of that small amount of hedges.  The knockouts and 3-ways aren't going to make-or-break the company in 2010, but they certainly wont help.  More important is simply that Chesapeake is the most exposed E&P to gas prices next year.  This is really the crux of my short argument, because if gas declines, Chesapeake will be the first company to feel it.  There's not really much else I can say about this point, it speaks for itself.

5) Chesapeake uses needlessly risky hedging strategies.  Last year, management came under quite a bit of fire for their reliance on knockout swaps.  Knockout swaps are fake hedges.  Chesapeake will enter into a swap and receive a slightly better price than they would with a plain vanilla swap.  So if the strip is at $6.00, they'd actually be able to hedge at $6.50.  The flipside is that if the underlying falls below a certain price, say $4.00, the whole deal gets called off and the counterparty walks away.  This is like getting health insurance that only covers a common cold and ear infection...the whole point is to be covered in case the crap hits the fan.  If you're an e&p company, there is no worse product than this, it defeats the entire purpose of hedging.  Still, Chesapeake continues to use knockouts for a good portion of their "hedges."  188 bcf (22%) is hedged in 2010 at about $8.50.  But 70 bcf of that is with knockouts that vaporize at prices between $5.45-6.75. 

Management also uses 3-way collars in addition to the knockouts.  A normal collar  involves selling a high priced call and buying a lower priced put, typically in a costless transaction.  It guarantees the producer will receive a price no lower than the put price, yet no higher than the call price.  But Aubrey implements 3-ways which include the extra transaction of selling a put at an even lower price, stretching for a little extra premium.  Again, if gas falls below your written put price, you'll find that you're no longer hedged as your written put is now costing you money.  26 bcf of 2010 production is hedged this way, with the puts ranging from $4.25-5.50.

6) Chesapeake uses the most aggressive assumptions when reporting well sizes (EUR's).  For example, management uses a 65 year reserve life to model Haynesville EUR's.  This is inappropriate, as the oldest Haynesville wells have only been on production for less than two years, and the oldest shale wells have only been around for 6-8 years.  Besides being inappropriate it's also irrelevant because it completely ignoring present value.  Management's take on this topic provides an example of both their character and judgment of returns.

"I have seen a number of other EURs from companies that are at 40 or 45 or 50 years and that actually means that our curves are more conservative, that it takes us 65 to get to say, 6.5 bcfe. So if somebody else is at 6.5 bcfe at 50 years, then it means that we probably have some upside in our EUR over time, if they are getting there in 50 years and our curves take 65 to get there..." - Aubrey McClendon, 8/4/09, Q2 Conference Call

You got that?  Aubrey is saying that he's the one being conservative by using the longest well life in the industry.  Good grief.  But does it even matter?  Anyone who knows freshman finance can tell you that whether you want to use 40 years, 50 years or 65 years, the present value difference is negligible in every case and worthless to me today.  Using an appropriate discount rate (the industry, for better or worse, clings to 10%...meanwhile, Chesapeake is issuing 10 year debt at 9.5%) anything beyond 30 years has no value at all. 

This also highlights one of the big problems in the industry, which is that F&D cost (capex divided by EUR) doesn't tell you much about profitability.  F&D doesn't change with the movement of gas prices in the short-term (it will in the long-run as service costs adjust), so it's generally the same whether gas is $10 and the well is insanely profitable or gas is $3 and the well is a money loser.  But if you actually model out these wells, including all the extra charges that the companies don't like to report, $6.00 gas is too low for most of these companies to make money.

7) Chesapeake is reshaping the company into what I suppose you could call a lease broker.  They had some extraordinary success doing JV's recently, so now they want to make it an official component of the company.  Actually, they appear to now be relying on these types of transactions in order to fund their capex program. 

"We are also in the often much more profitable business of identifying and developing big unconventional plays and selling leases in those plays to other companies who perhaps have not yet developed all of our capabilities in developing these big unconventional plays on their own. We believe this is perhaps the simplest part of our business model, but somewhat mysteriously to us, many observers of our company apparently find this aspect of our business model difficult to understand or appreciate." - Aubrey McClendon, 11/3/09, Q3 Conference Call

Actually, it's not difficult to understand, but it is difficult to value. 

8) In present value terms, Chesapeake's leases are worth a lot less than people think.  The idea is simple.  Let's say you're an E&P company and you've got 500,000 quality acres in a good shale play.  Wells have an average EUR of 5 Bcfe, with an optimal spacing of 80 acres, leaving you with 6,250 potential locations and 31.3 Tcfe of unbooked reserves.  Many management teams and analysts will look at this, assign a value of $.50 per unbooked reserve and call it a day thus creating $15.5 billion in value ($31,000/acre) just like that.  Sometimes they'll "risk" it by haircutting the figure by 50% or so, but they're really only doing that so that their valuation doesn't look ridiculous.  Let's also assume that it takes 30 days to drill a well, so one rig can drill 12 wells per year, while a well costs $5 million.  Now we're looking at a schedule like this.

 

Rigs 10 20 30 40 50
Wells/Year 120 240 360 480 600
Years of Inventory 52 26 17 13 10
Total Capex 600 1,200 1,800 2,400 3,000

 

Here's the problem with having such a large acreage position - if you don't put a ton of rigs to work in it, it will take you a generation or two to drill all of your wells.  Having a 20, 30 or 40 year backlog of inventory is a terrible thing once you account for the cost of the lease, the capitalized interest, the landmen and corporate and legal expense, etc...these leases now have a negligible or negative PV.  As an investor today, why should I care about a well we're going to drill in 2039???  What kind of discount rate do you even use on that???  And how do you account for the fact that this particular company cant grow without diluting shareholders?  Because of this, there are diminishing marginal returns to having a large acreage positions like Chesapeake's.  When Chesapeake signs new Haynesville leases, that new acreage either goes to the back of the line in which case it's got a negative PV, or it goes to the front of the line which means some other lease essentially got condemned.  Companies talk all the time about "high grading" their acreage, but all this really is is an admission that they lost millions of dollars in leases signed a few years ago.  This is one of the problems with gigantic companies like Chesapeake - they'll never be able to drill up all of the acreage, yet many people still assign it equity value anyway.  And those analyses are essentially assuming that those future wells are profitable at all...remember, at today's prices many companies are losing money. 

So what are the Chesapeake's of the world forced to do to counteract this PV problem?  Drill the crap out of their acreage.  Gas prices too low?  Screw it, gotta keep drilling. Service costs too high?  Can't afford to stop drilling.  They've got to pull as much of that production forward as possible...and I'm not even accounting for lease expirations.  This helps explain why Chesapeake is planning to spend 45% more on drilling in 2010 even though gas prices remain exceptionally weak.  Below lists Chesapeake's main stats on their featured shale plays.  I believe that if you use an appropriate discount rate for a company like Chesapeake, anything beyond 10 years out has zero value.

  Haynesville Marcellus Fayetteville Barnett Colony Wash Granite Wash Total
Acres 510,000 1,520,000 445,000 200,000 60,000 40,000 2,775,000
Spacing 80 80 80 60 160 160  
Locations 6,375 19,000 5,563 3,333 375 250 34,896
Rigs 38 28 12 12 4 11 105
Drill Days 50 30 20 20 50 40  
Wells/Year 277 341 219 219 29 100 1,186
Capex/Well 7.0 5.0 3.0 2.7 6.3 5.5  
Years of Inventory 23 56 25 15 13 2 29
Total Capex 44,625 95,000 16,688 9,000 2,363 1,375 169,050

Now you might argue that this acreage still commands a high value because it's worth that price to someone who isn't in the play.  I would say normally, this would be correct, but these are some odd times.  First of all, the nat gas market is broken right now and I believe headed even lower.  The appetite for non-cash flowing leases is soft and will probably get worse.  Second, almost every E&P now has a sizable acreage position in one shale or another.  No one is desperate to get into a play anymore, virtually every E&P has some kind of meaningful shale position to exploit. 

9) Chesapeake began using off balance sheet financing in recent quarters.  In January 2008, Chesapeake announced their first volumetric production payment (VPP) in the sale of 210 Bcfe for $1.1 billion to Deutsche Bank and UBS.  Four more VPP's have since followed, all told Chesapeake has raised $3.1 billion by selling 570 Bcfe of reserves through VPP's.  Investors love these deals, and while I agree that they've been good transactions for Chesapeake, I don't think the market really understands what VPP's truly are.

VPP's are transactions whereby a company agrees to deliver a certain amount of gas from a field(s) over a specified time frame via an overriding royalty interest.  The seller is required to maintain production, pay all expenses and taxes, retain all environmental liabilities, and will take back the sellers interest after the maturity.  The buyer receives the production free and clear of all expenses - they're only purchasing the revenue stream.  They then hedge out the price risk to lock in a yield that meets their particular rate-of-return hurdle.  Basically, the seller is selling a temporary revenue interest in a group of wells where the production has a small risk of underperforming.  The whole deal is usually off balance sheet for the seller.  The reserves in the deal are considered divestitures and the company books the cash received without accounting for the obligation to deliver the gas to the buyer or any gain-on-sale.  The seller must still spend capital to maintain production as if they still owned the field outright.

What's interesting about VPP's is that they allow the seller to report some impressive sale prices to the public.  For example, in Chesapeake's last VPP in July they sold 68 Bcfe for $5.55/reserve.  Considering gas was trading for $4.00 and the market tends to value PDP's around $1.50-1.75, this was one hell of a deal for Chesapeake.  This is typical of VPP's, since the price/reserve metrics are usually done at small discounts to the strip pricing.  Management touts their enviable sale metrics to the public and gets to report a deleveraging of the balance sheet, meanwhile everyone is awestruck that this company is smarter than everyone else and a lot more sophisticated at executing asset sales.

But there's a lot more going on here. How can a company sell PDP's at prices above the spot price of gas, while the market typically values them at a fraction of gas?  In reality, VPP's are not asset sales at all, they are secured loans that remain off balance sheet in SPE's (as long as the company uses Full Cost accounting, which Chesapeake does)...they're the CDO's of the E&P world, it's nothing more than a securitization that arbitrages the cost of capital vs the contango in the strip.  VPP's are rated by S&P/Moody's.  It's usually banks who provide the capital.  The deals require reserve overcollateralization.  They're non-recourse to the buyer and bankruptcy remote.   The asset is transferred back to the buyer after maturity.  Sure sounds like debt to me, yet Chesapeake is allowed to report them as asset sales.  What is it that makes  VPP's look so attractive when a company like Chesapeake reports them?  Unlike a normal loan which is made against cash flow, a VPP is a loan made against revenue.  VPP's are like getting a commercial mortgage based on rents instead of FFO.  Of course you can borrow more when you're guaranteeing the lender your revenues while you remain on the hook for all of the expenses and production risk.

I'll admit that VPP's are lower risk debt because of the production profile of the wells, but it's debt nonetheless.  There's exposure to the seller in that they have to pay for all of the production expense (typically high for VPP wells), transportation, G&A, workovers, but they can't ever shut-in or suspend operations.  Do I think the use of VPP's is necessarily inappropriate, or puts the company's future in peril?  Not really.  But they are still $3.1 billion in debt instruments that management is able to hide, and the expenses associated with these deals are ongoing fixed costs (maybe $130-150 million annually) that management wont talk much about. 

10) Management compensation is as ridiculous as any company you'll find.  The issues with Aubrey's pay are well known even outside of the energy world.  I encourage people to read the 2008 proxy cover to cover, it's filled with all sorts of goodies including Aubrey selling his $12 million map collection to Chesapeake (your capex dollars at work!), Aubrey steering events to a restaurant he owns, $1.4 million billed to Chesapeake in the last four years for Aubrey's accounting support (two words, dude: Turbo Tax), and plenty of other interesting stuff.  Did I mention he got paid over $100 million in 2008?

What Chesapeake Has Going For Them

My hat goes off to Aubrey in one regard - he managed to pull off one of the most one-sided JV agreements in history by selling a 110,000 Haynesville acres to Plains Exploration for $28,000/acre.  Plains should've filed a police report for getting ripped off that badly, but I guess the Kool-Aid was flowing like water at the time.  Plains needs $8.00 gas just to be breakeven on the deal.  Aubrey also executed two other JV's (Statoil in the Marcellus, BP in Fayetteville) while selling the Woodford Shale properties at high prices.  These deals were admittedly great for Chesapeake and provided desperately needed cash infusions which probably saved the company.  They also have drilling carry clauses in their JV's which mean that up until $X are spent, the partner has to put up say, 50% of the capital in order to receive a 20% interest, after which point the working interests revert back to the normal ratios.  Normally, the carries are a great deal for Chesapeake  because they earn a much better return on their investment.  Unfortunately, at current prices those reserves just aren't worth that much.  This is an extremely important point, and it's why Aubrey loves to talk about F&D while brushing aside PV10.  The sad reality is that much like selling telecom equipment in the early 2000's or selling newspapers today, producing nat gas isn't a very profitable business right now, and it might take a few years to get back to normal.  While they do  have the drilling carries, Chesapeake would be 1,000 times better off if they just received all of the money up-front in cash and paid down debt.  Through these JV's Chesapeake amazingly did show that they might sorta understand the concept of PV, although they were also under serious liquidity constraints which helped guide their behavior.

Cash Flow Valuation

This analysis is predicated on two macro assumptions.  First, that in 2010 gas prices hit very low levels.  Second, gas prices will probably remain low throughout the next few years as the industry goes through a painful shakeout process.

Let's take management at their word about 2010 production growth of 8-10%.  Next year, Chesapeake will produce 900 bcf of gas (2.48 bcf/d) and 12.5 million barrels of oil (34 mbbl/d).  I am using wellhead prices of $3.00 gas and $65 oil.  They'll make $3.5 billion from production, after half of their hedges get blown up they'll make $680 million from hedging, and they'll make another $120 million from service and midstream businesses.  Assume $1.04/mcf in production expense, 3.7% of oil/gas revenues in severance tax expense, and $.41/mcf in G&A and they'll generate about $2.8 billion in EBITDA and $1.9 billion in cash flow ($2.90/share).  Every $.10 change in gas prices affects EBITDA by about $78 million.  No EBITDA multiple will save them in this case, so just valuing it at 4x cash flow, which is the historical average and very reasonable, the stock is only worth $12/share.

On the spending side, they'll incur about $900 million in cash interest charges, they'll spend about $4.6 billion drilling wells, $260 million in seismic, $190 million in common dividends, back out $120 million in option expense, which all totals negative $2.5 billion.  So now they've got, as usual, a funding problem.  Management has already guided for $1.0-1.4 billion in asset sales, but these are highly uncertain and still wont be enough to plug the hole.  Chesapeake will be forced to tap the markets for more capital, which will crush the stock, or they'll slash their capex which means another year of no/negative growth. 

Gas Bcf

902

Oil Mmbbl

12.5

Gas Bcfe

903

 

 

Gas Px

3.00

Oil Px

65.00

 

 

Oil/Gas Sales

3,519

Hedges

647

Marketing

2,185

Service

200

Revenue

6,551

 

 

Production

1,014

Severance

128

G&A

406

Marketing

2,076

Service

190

Expenses

3,814

 

 

EBITDA

2,737

 

 

Interest

-900

 

 

Cash Flow

1,837

CFPS

2.89

 

 

Drilling

-4,600

Seismic

-260

Options

120

Dividends

-188

 

 

FCF

-3,091

 

 

Shares

635

There is another problem here which is that Chesapeake will easily trip their debt/EBITDA covenant of 3.75:1 on their revolver next year.  They are actually very close to tripping it today, as of 9/30/09 the ratio stood at 3.48:1 and that's with the benefit of some higher prices from 9-12 months ago.  Although the banks would likely modify the covenant, it's still possible the maturity of the loan could be accelerated to be due immediately.  The banks might feel different if gas averages $3.00 throughout 2010, and Chesapeake's debt/EBITDA spikes to 5.0x. 

Some notes about their financial reporting.  Chesapeake capitalizes about 75% of their interest so it wont screen well as being dangerously levered.  I add all capitalized interest to the income statement.  Also, debt is $1 billion higher than what is stated, as they back out the negative equity value from their converts ($2.7 billion total outstanding, the conversion prices are all much higher than the current stock price).  I calculate that as of 9/30/09, Chesapeake has $13.5 billion in debt ($460 million is preferred stock) and $520 million in cash.  The weighted average interest rate on the debt is 6.5%.

NAV Valuation

This analysis certainly has its merits, but it's important to understand that Chesapeake has levered up to buy non-cash flowing assets, and the value of their assets can change dramatically with changes in gas prices and investors can stop caring about the value of the non-cash flowing assets in a hurry.  When things go south, people start valuing these companies on how much they actually make rather than what their NAV is.

Their PV10 is only 68% producing reserves, so I haircut it to avoid double counting the PUD's and the leases.  A PUD is nothing more than a low risk lease, but because of the economics and success rate of shale it really doesn't matter much what a company tells you their PUD's are, any dummy can figure it out (btw, accounting rule changes will soon allow companies to book whatever the feel like as PUD's, so people are going to start getting used to separating the PUD's from the PDP's in the NAV's).  My sensitivity is based on management's guidance that every $.10 change in NYMEX affects PV10 by $400 million (at 68% it's $272 million).  I'm using the 9/30/09 as the reference point, which reported $7.6 billion in PV10 ($5.2 billion for the PDP) at $3.30 NYMEX.  My sensitivity comes out pretty close to prior quarters of what the company has reported.  The midpoint is current NYMEX. 

  PV10 (PDP only)
Reserves (bcfe) 3.00 3.30 4.40 5.25 6.50
12,000 4,352 5,168 8,160 10,472 13,872

On the acreage I do my best to account for a couple things.  First, they report their total net leasehold position, so I try to back out the developed acreage based on various data points.  Second, areas like the Marcellus are highly variable and while they report having 1.5 million acres a much smaller percent of that is worth anything.  For example, they have a ton of acreage in New York and West Virginia which is hardly worth anything at all.  Finally, I'll admit that they've got hundreds of thousands of other leases, but I just don't know how to value them, the company doesn't provide enough information.  I'm trying to only focus on the high impact plays. 

      Prices   Values
Area Acres   Low Med High   Low Med High
Haynesville 495   3,000 5,000 10,000   1,485 2,475 4,950
Marcellus 1,500   700 1,200 2,000   1,050 1,800 3,000
Fayetteville 445   1,500 3,000 5,000   668 1,335 2,225
Barnett 198   500 1,000 2,000   99 198 396
Colony Wash 55   1,000 1,500 2,000   198 297 396
Granite Wash 38   2,500 3,000 5,000   95 114 190
Total             3,595 6,219 11,157

Here is what remains beyond reserve related assets.  It's mostly the midstream business and various equipment.

Asset Value
Midstream 3,300
PP&E 1,650
Rigs, equip 610
Compressors 300
Misc 540
Investments 422
Working Cap -2,760
Derivatives 460
Total 4,522

Tie it all together and here's what we've got.  Obviously, this is a strikingly wide range of values, but even in an optimistic scenario the company is fairly valued today.  I feel pretty confident about the midpoint being the appropriate mid/long-term valuation to use because of the broken fundamentals in the nat gas market.  So either way I value this company, I think fair price is about $10/share. 

Asset Low Med High
PV10 4,352 8,160 13,872
Leases 3,595 6,219 11,157
Misc 4,522 4,522 4,522
Cash 520 520 520
Debt -13,000 -13,000 -13,000
Preferred -460 -460 -460
Equity -472 5,961 16,611
       
Shares 635    
       
Price -0.74 9.39 26.16

Conclusion

Here's how I think this plays out.  Next year gas sinks to $3.00 or less and all of the stocks get [ahem] drilled.  Shorts start circling Chesapeake for having the worst management, the highest debt, and the fewest hedges.  Analysts start to press management on why they're spending $4.6 billion on drilling (a 45% increase yoy) when gas is so low and they're losing money.  The company has a difficult time finding buyers for assets at reasonable prices, and as Aubrey's history with hedging shows he's willing to risk the entire company to get a better price on a deal.  Liquidity problems emerge as debt covenants gets tripped and we replay the events of 2008.

So management either (a) significantly reduces the capex budget, which kills growth while still doing little to delever the balance sheet, (b) sells more assets than anticipated, and at lousy prices, or (c) issues a lot more equity to plug the gap and show some kind of deleveraging (my guess is over $1 billion, so maybe another 12-20% dilution, but who knows).   I bet you'll see a combination of all three, but in any case the stock will get killed and I think it will trade down to about $10/share, perhaps lower if there's real panic, which is entirely possible with this company...nothing would surprise me at this point. 

The sell-side gets this stock all wrong because (a) they take management at their word about future multi-billion dollar asset sales, (b) they remain anchored to their NAV's, (c) their nat gas estimates are still too high, often well above current strip, (d) they don't properly account for capitalized interest in their CFPS estimates, and (d) Chesapeake generates millions in fees for these firms...they're a banker's dream.

I realize a lot of this is predicated on sharply lower gas prices, so what if I'm wrong about my gas call?  Using the current strip ($5.25 average for 2010; knockouts and 3-ways stay intact), Chesapeake is still FCF negative by $1.0 billion in 2010 assuming no asset sales.  They'll generate $4.7 billion in EBITDA, which at 5.0x (this might be generous) is a fair value of $17/share.  Alternatively, cash flow per share will be about $6.00, which at 4x is $24/share.  Using 2011 strip price average of $6.15 gets you to $5.4 billion in EBITDA and $7.00/share in cash flow, for a mid-high $20's price target.  What is the upside to this stock???  Even if gas prices rally Chesapeake will always garner a valuation discount because of management and the high debt load.  The bottom line is that this company only works if gas is much, much higher, which is why in their own guidance they're forced to use $7.00 and $7.50 gas prices for 2010 and 2011, respectively.

 

Catalyst

Nat gas moves lower

Equity raise

Capex cuts

Analyst downgrades

    sort by    

    Description

    Chesapeake is a company that's easy to hate.  A messy balance sheet, an awful management team, and the street loves it.  This recommendation has two components.  First is a macro call and my opinion that we will see a stunning crash in gas prices in the next two years.  Second is that CHK is not only a company completely void of any serious long-term investment merits, but will also be adversely affected worse than most E&P's if gas goes lower.

    Nat Gas: A History

    I realize the inherent risk in recommending a crash in gas prices have already gone from $13 to $5, but that's what I think is going to happen.  Here's a very brief history lesson on gas.  For a long time gas production in the US was flat despite more drilling and more spending - we were running to stand still.  In the early 2000's the industry finally figured out how to produce gas from shale through new technologies, primarily horizontal drilling and fracture stimulation.  As more companies got into the shale game, which is unimaginably large, and the techniques were refined, gas production in the US began to increase by 5-10% annually, at an accelerating rate.  People were so euphoric about all the new reserves they forgot that overall, this much gas is bad for business.  So in 2008, prices crashed with the rest of commodities as demand vanished, while investors started to wonder whether the long-term fundamentals, driven by tons of new shale reserves and a weak economy, would keep gas prices low for a long time. 

    Now we're at a place where prices are low and people are expecting the Econ 101 reaction from the industry, which is to produce less and watch prices rise.  Many forecasts have been made about this rational expectation, with 2010 estimates ranging from down 3% to down 12%.  Regardless, if there's one thing that almost everyone can agree on is that production needs to decline, otherwise we're in a lot of trouble.  There is almost no debate on this, we are simply producing too much gas right now...heck, we were producing too much gas before the recession when demand was strong.  And almost universally, people are expecting huge production declines in 2010.

    Nat Gas: Why 2010 Is Going To Be Ugly

    In 2009 people started building models to forecast the supply/demand picture for gas.  Analysts started looking at well decline curves (very steep for shale), rigs employed, initial production (IP) rates, capital spending, etc in order to gauge where there thought supply would bottom.  There are 3 macro models that are notable.  Two are from energy boutique investment banks - Tudor Pickering Holt, and Simmons & Co.  The third model is from none other than Chesapeake, as they are one of the few companies to publicly talk about their own model, and many people seem to look at them for macro insight.  

    The TPH model was unveiled to much hullabaloo a few weeks ago, complete with a fancy slide deck and conference call.  They have modeled out about 25 basins from the ground up, forecasting production by using an average well curve and ratcheting the rig count up or down.  Simmons has done something similar, as has Chesapeake I believe.  These models are unstable and reminiscent of CDO models.  I know this because it's easy to build a model for say, the Fayetteville Shale, I've done it myself.  The problem you find is that very small changes in your inputs - days to drill, first year decline, increasing efficiencies - can have game changing effects on the results.  

    These models are proving to be incorrect for one basic reason: newer shale wells have very high initial production.  For example, a Haynesville Shale well might produce 5-7x the amount of a Barnett Shale well, therefore cutting the rig count wont matter because most of the incremental production easily offsets the 50% decline in rigs.  Production is declining in certain areas like the Barnett Shale, but new, larger plays like the Haynesville Shale and Marcellus Shale are offsetting the losses.  I say forget the production models, if it's future production data you want, ask and ye shall receive.  Just poll the companies who actually produce gas, and see what they say they're going to do.  I looked at 40 of the largest US gas producers, and what they are telling you is the exact opposite of what analysts and companies are predicting. 

    Despite what everyone is forecasting about production being down in 2010, I could only find 7 companies who have either guided lower US gas production or the street expectation is for a production decline.  These 7 companies only represent about 15% of total US production.  Meanwhile, when you look at the 40 largest companies and do a weighted average based on current production, as a whole these firms plan to increase production by 5% next year.  Combined, they make up about 60% of total US production.  This would mean that in order for 2010 production to stay flat, private companies would have to cut production by 5%.  In order to hit TPH's target of down 7%, private companies would have to cut by 22%.  And to hit Chesapeake's target of down 11%, private companies would have to cut by 33%.  Those production declines will never happen, and I expect 2010 will be an historically bad year for nat gas.

     Other than company guidance, why am I so sure that production will remain too high in 2010?  First, capex budgets were already down substantially in 2009, and companies appear very reluctant to cut them further.  They see 2009 as the adjustment year, they're not ready for another year of pain.  Second, the industry has raised billions in fresh capital and has delevered quite a bit, so they've still got money to spend.  Third, it's what managements are paid to do.  These guys' bonuses are mostly based on production growth either directly or through other measures that derive from production such as EBITDA and reserve replacement.  If you're not growing, you're not getting paid...shrinking companies isn't in their DNA (at least not intentionally).  Finally, most companies have hedged 2010 production at decent prices, so they wont necessarily be forced to slash their budgets. 

    The fact of the matter is that today's prices are the worst possible place for the industry.  Nat gas is high enough that there's no immediate need to hit the panic button and firms can increase production in the aggregate (for now).  Unfortunately, prices are also low enough that very few firms are creating any value, and living within cash flow is leading to weak growth.  I was reassured by my take on all this when Ken Peak, the CEO of value junkie favorite Contango Oil & Gas, and probably the smartest CEO in the energy business, had this to say:

    "Industry supply trends together with my gleanings from a number of recent industry conference calls lead me to believe the industry may be on its way to drilling gas prices back to the $2.00 to $4.00/Mcf price level. Even though demand for natural gas is likely increasing, supply from the onshore lower 48 since November 2008 has been basically flat despite an approximate 50% drop in rigs drilling for natural gas. In essence the increase in production from shale wells has overcome ongoing industry-wide geologic decline while drilling significantly fewer wells. Thus, a second round of gas price declines may be in front of us." - Ken Peak, 11/9/09, first quarter press release

    At some point all this has got to stop.  The only way to get aggregate production to a stable level that allows prices to rise is to physically cut these companies off from their sources of capital.  And the banks/shareholders are complicit until they're forced to stop.  The only way I see this happening is if there are some blowups (or near-deaths) in the industry and people become much more suspicious about giving these companies money.  There is going to be an ugly transition in this industry, and as the growth rates and profitability come down they'll bring stock prices with them.  I find it amazing that many E&P's were hitting 52 week highs just 2-3 weeks ago.

    Chesapeake: At Best A Stock You Never Want To Own 

    1) The historical performance of this company is terrible, but you'd never know it from listening to management.  Aubrey cant open his mouth without talking about "shareholder value creation", although he uses it as nothing more than a hollow catchphrase.  

    "This singular focus gives us a chance to be the very best in the industry at one thing, and when you can be the best at one thing you have a chance to create increases in shareholder value year after year." - Aubrey McClendon, 2/25/03, Q4 Conference Call 

    "We are now distinctively positioned to continue reaping the rewards from those timely investments, and to continue delivering top-tier shareholder value for years to come." Aubrey McClendon, 2/23/05, Q4 Conference Call 

    "I believe you will be very impressed with what we will deliver to you in shareholder value creation in the years to come." - Aubrey McClendon, 10/27/06, Q3 Conference Call 

    "We don't believe you can find a better combination of great growth and value in the industry and are excited about the shareholder value creation that has occurred to date." - Aubrey McClendon, 5/2/08, Q1 Conference Call 

     "I believe in what I do for a living; I create value...While this company has had its ups and downs along the way, we have consistently delivered shareholder value over long periods of time and we will continue that in the years ahead...it's there today; you can't see it, but it is there, and it will be recognized over time." - Aubrey McClendon, 6/19/09, Annual Meeting [this one's my favorite] 

    If Chesapeake has created so much shareholder value, why do they have negative retained earnings?  Why is the entire book value of this company paid-in-capital?  All of those impairment charges add up...they weren't non-cash when you spent the money.  Why has Chesapeake's stock underperformed other large-cap E&P's by 40%, and larger shale-focused companies by 55% in the last 10 years?  It's actually the worst performing stock over the last 2, 6 and 12 years among its comp group.  Chesapeake trades at the same price today as it did when "Macarena" when the #1 Billboard song (Summer 1996).  Why has the debt-adjusted production and reserves per share declined over time?  This company has done nothing but destroy value, and I believe they will continue on this path indefinitely.

    2) Chesapeake is a chronic issuer of new capital, with little to show for it.  In this decade, Chesapeake has sold $10.4 billion in common and preferred stock and raised $12.3 billion in net debt.  The shares outstanding have increased over fourfold, from 150 million to 625 million.  Against this, Chesapeake has returned $600 million to shareholders via dividends and buybacks.  Net capital invested is $23.2 billion.  What has all that money bought?  How about a PV10 of $7.6 billion, $5-12 billion in unproved acreage, and $4 billion in other stuff.  Meanwhile, the company sports an enterprise value of $28.9 billion.

    Chesapeake had gone on a company/acreage acquisition binge throughout the early/mid 2000's, constantly outspending cash flow.  Shareholders were getting fed up with the capital raises even then, so around 2006-2007, after the $2.3 billion acquisition of Columbia Natural Resources, the story about the company changed.  Management repeatedly stated that the asset accumulation phase was over, and now was the time to harvest those best-in-class assets and finally watch the per share production/reserve/cash flow metrics take off.

    "Nothing else has to work for us. No acquisitions, no stealth plays. We just keep our heads down and keep drilling ahead on the acreage that we own...please recall that now we can deliver all of this value creation without adding debt or increasing our share count." - Aubrey McClendon, 2/15/08, Q4 2007 Conference Call

    Net increase in debt since that quote: $2 billion.  Net share count increase: 150 million, or 31.5%.  This management simply does not know how to run a business without continually diluting shareholders. 

    3) Aubrey McClendon is a terrible CEO and is single-handedly responsible for Chesapeake's poor performance.  He took Chesapeake to the brink of ruin in the late 1990's by levering up the company to go after the Austin Chalk, then getting killed when the Chalk wasn't that good and gas prices plummeted.  Last year he almost blew it up again by levering up to buy billions of new leases right before gas prices crashed.  And in an event that redefined schadenfreude, Aubrey almost became a household name in 2008 from getting the mother of all margin calls, losing $2 billion and single handedly tanking the stock of his company.  He has proven time and time again that he does not understand the concepts of value creation or risk management.  The third quarter conference call was particularly enlightening, it gives you a good flavor for what he's like.  Among the things he discussed: 

    He's notorious for being one of the most promotional CEO's in the industry.  I would encourage people to read his opening remarks from the last couple years' conference calls, it's nothing but pure bewilderment over the "value creation" that goes on at the company.

    4) Chesapeake is one of the least hedged companies in the industry at 22% in 2010...heck, management seems downright proud of this.  And with the knockouts and 3-ways they're at risk of losing 50% of that small amount of hedges.  The knockouts and 3-ways aren't going to make-or-break the company in 2010, but they certainly wont help.  More important is simply that Chesapeake is the most exposed E&P to gas prices next year.  This is really the crux of my short argument, because if gas declines, Chesapeake will be the first company to feel it.  There's not really much else I can say about this point, it speaks for itself.

    5) Chesapeake uses needlessly risky hedging strategies.  Last year, management came under quite a bit of fire for their reliance on knockout swaps.  Knockout swaps are fake hedges.  Chesapeake will enter into a swap and receive a slightly better price than they would with a plain vanilla swap.  So if the strip is at $6.00, they'd actually be able to hedge at $6.50.  The flipside is that if the underlying falls below a certain price, say $4.00, the whole deal gets called off and the counterparty walks away.  This is like getting health insurance that only covers a common cold and ear infection...the whole point is to be covered in case the crap hits the fan.  If you're an e&p company, there is no worse product than this, it defeats the entire purpose of hedging.  Still, Chesapeake continues to use knockouts for a good portion of their "hedges."  188 bcf (22%) is hedged in 2010 at about $8.50.  But 70 bcf of that is with knockouts that vaporize at prices between $5.45-6.75. 

    Management also uses 3-way collars in addition to the knockouts.  A normal collar  involves selling a high priced call and buying a lower priced put, typically in a costless transaction.  It guarantees the producer will receive a price no lower than the put price, yet no higher than the call price.  But Aubrey implements 3-ways which include the extra transaction of selling a put at an even lower price, stretching for a little extra premium.  Again, if gas falls below your written put price, you'll find that you're no longer hedged as your written put is now costing you money.  26 bcf of 2010 production is hedged this way, with the puts ranging from $4.25-5.50.

    6) Chesapeake uses the most aggressive assumptions when reporting well sizes (EUR's).  For example, management uses a 65 year reserve life to model Haynesville EUR's.  This is inappropriate, as the oldest Haynesville wells have only been on production for less than two years, and the oldest shale wells have only been around for 6-8 years.  Besides being inappropriate it's also irrelevant because it completely ignoring present value.  Management's take on this topic provides an example of both their character and judgment of returns.

    "I have seen a number of other EURs from companies that are at 40 or 45 or 50 years and that actually means that our curves are more conservative, that it takes us 65 to get to say, 6.5 bcfe. So if somebody else is at 6.5 bcfe at 50 years, then it means that we probably have some upside in our EUR over time, if they are getting there in 50 years and our curves take 65 to get there..." - Aubrey McClendon, 8/4/09, Q2 Conference Call

    You got that?  Aubrey is saying that he's the one being conservative by using the longest well life in the industry.  Good grief.  But does it even matter?  Anyone who knows freshman finance can tell you that whether you want to use 40 years, 50 years or 65 years, the present value difference is negligible in every case and worthless to me today.  Using an appropriate discount rate (the industry, for better or worse, clings to 10%...meanwhile, Chesapeake is issuing 10 year debt at 9.5%) anything beyond 30 years has no value at all. 

    This also highlights one of the big problems in the industry, which is that F&D cost (capex divided by EUR) doesn't tell you much about profitability.  F&D doesn't change with the movement of gas prices in the short-term (it will in the long-run as service costs adjust), so it's generally the same whether gas is $10 and the well is insanely profitable or gas is $3 and the well is a money loser.  But if you actually model out these wells, including all the extra charges that the companies don't like to report, $6.00 gas is too low for most of these companies to make money.

    7) Chesapeake is reshaping the company into what I suppose you could call a lease broker.  They had some extraordinary success doing JV's recently, so now they want to make it an official component of the company.  Actually, they appear to now be relying on these types of transactions in order to fund their capex program. 

    "We are also in the often much more profitable business of identifying and developing big unconventional plays and selling leases in those plays to other companies who perhaps have not yet developed all of our capabilities in developing these big unconventional plays on their own. We believe this is perhaps the simplest part of our business model, but somewhat mysteriously to us, many observers of our company apparently find this aspect of our business model difficult to understand or appreciate." - Aubrey McClendon, 11/3/09, Q3 Conference Call

    Actually, it's not difficult to understand, but it is difficult to value. 

    8) In present value terms, Chesapeake's leases are worth a lot less than people think.  The idea is simple.  Let's say you're an E&P company and you've got 500,000 quality acres in a good shale play.  Wells have an average EUR of 5 Bcfe, with an optimal spacing of 80 acres, leaving you with 6,250 potential locations and 31.3 Tcfe of unbooked reserves.  Many management teams and analysts will look at this, assign a value of $.50 per unbooked reserve and call it a day thus creating $15.5 billion in value ($31,000/acre) just like that.  Sometimes they'll "risk" it by haircutting the figure by 50% or so, but they're really only doing that so that their valuation doesn't look ridiculous.  Let's also assume that it takes 30 days to drill a well, so one rig can drill 12 wells per year, while a well costs $5 million.  Now we're looking at a schedule like this.

     

    Rigs 10 20 30 40 50
    Wells/Year 120 240 360 480 600
    Years of Inventory 52 26 17 13 10
    Total Capex 600 1,200 1,800 2,400 3,000

     

    Here's the problem with having such a large acreage position - if you don't put a ton of rigs to work in it, it will take you a generation or two to drill all of your wells.  Having a 20, 30 or 40 year backlog of inventory is a terrible thing once you account for the cost of the lease, the capitalized interest, the landmen and corporate and legal expense, etc...these leases now have a negligible or negative PV.  As an investor today, why should I care about a well we're going to drill in 2039???  What kind of discount rate do you even use on that???  And how do you account for the fact that this particular company cant grow without diluting shareholders?  Because of this, there are diminishing marginal returns to having a large acreage positions like Chesapeake's.  When Chesapeake signs new Haynesville leases, that new acreage either goes to the back of the line in which case it's got a negative PV, or it goes to the front of the line which means some other lease essentially got condemned.  Companies talk all the time about "high grading" their acreage, but all this really is is an admission that they lost millions of dollars in leases signed a few years ago.  This is one of the problems with gigantic companies like Chesapeake - they'll never be able to drill up all of the acreage, yet many people still assign it equity value anyway.  And those analyses are essentially assuming that those future wells are profitable at all...remember, at today's prices many companies are losing money. 

    So what are the Chesapeake's of the world forced to do to counteract this PV problem?  Drill the crap out of their acreage.  Gas prices too low?  Screw it, gotta keep drilling. Service costs too high?  Can't afford to stop drilling.  They've got to pull as much of that production forward as possible...and I'm not even accounting for lease expirations.  This helps explain why Chesapeake is planning to spend 45% more on drilling in 2010 even though gas prices remain exceptionally weak.  Below lists Chesapeake's main stats on their featured shale plays.  I believe that if you use an appropriate discount rate for a company like Chesapeake, anything beyond 10 years out has zero value.

      Haynesville Marcellus Fayetteville Barnett Colony Wash Granite Wash Total
    Acres 510,000 1,520,000 445,000 200,000 60,000 40,000 2,775,000
    Spacing 80 80 80 60 160 160  
    Locations 6,375 19,000 5,563 3,333 375 250 34,896
    Rigs 38 28 12 12 4 11 105
    Drill Days 50 30 20 20 50 40  
    Wells/Year 277 341 219 219 29 100 1,186
    Capex/Well 7.0 5.0 3.0 2.7 6.3 5.5  
    Years of Inventory 23 56 25 15 13 2 29
    Total Capex 44,625 95,000 16,688 9,000 2,363 1,375 169,050

    Now you might argue that this acreage still commands a high value because it's worth that price to someone who isn't in the play.  I would say normally, this would be correct, but these are some odd times.  First of all, the nat gas market is broken right now and I believe headed even lower.  The appetite for non-cash flowing leases is soft and will probably get worse.  Second, almost every E&P now has a sizable acreage position in one shale or another.  No one is desperate to get into a play anymore, virtually every E&P has some kind of meaningful shale position to exploit. 

    9) Chesapeake began using off balance sheet financing in recent quarters.  In January 2008, Chesapeake announced their first volumetric production payment (VPP) in the sale of 210 Bcfe for $1.1 billion to Deutsche Bank and UBS.  Four more VPP's have since followed, all told Chesapeake has raised $3.1 billion by selling 570 Bcfe of reserves through VPP's.  Investors love these deals, and while I agree that they've been good transactions for Chesapeake, I don't think the market really understands what VPP's truly are.

    VPP's are transactions whereby a company agrees to deliver a certain amount of gas from a field(s) over a specified time frame via an overriding royalty interest.  The seller is required to maintain production, pay all expenses and taxes, retain all environmental liabilities, and will take back the sellers interest after the maturity.  The buyer receives the production free and clear of all expenses - they're only purchasing the revenue stream.  They then hedge out the price risk to lock in a yield that meets their particular rate-of-return hurdle.  Basically, the seller is selling a temporary revenue interest in a group of wells where the production has a small risk of underperforming.  The whole deal is usually off balance sheet for the seller.  The reserves in the deal are considered divestitures and the company books the cash received without accounting for the obligation to deliver the gas to the buyer or any gain-on-sale.  The seller must still spend capital to maintain production as if they still owned the field outright.

    What's interesting about VPP's is that they allow the seller to report some impressive sale prices to the public.  For example, in Chesapeake's last VPP in July they sold 68 Bcfe for $5.55/reserve.  Considering gas was trading for $4.00 and the market tends to value PDP's around $1.50-1.75, this was one hell of a deal for Chesapeake.  This is typical of VPP's, since the price/reserve metrics are usually done at small discounts to the strip pricing.  Management touts their enviable sale metrics to the public and gets to report a deleveraging of the balance sheet, meanwhile everyone is awestruck that this company is smarter than everyone else and a lot more sophisticated at executing asset sales.

    But there's a lot more going on here. How can a company sell PDP's at prices above the spot price of gas, while the market typically values them at a fraction of gas?  In reality, VPP's are not asset sales at all, they are secured loans that remain off balance sheet in SPE's (as long as the company uses Full Cost accounting, which Chesapeake does)...they're the CDO's of the E&P world, it's nothing more than a securitization that arbitrages the cost of capital vs the contango in the strip.  VPP's are rated by S&P/Moody's.  It's usually banks who provide the capital.  The deals require reserve overcollateralization.  They're non-recourse to the buyer and bankruptcy remote.   The asset is transferred back to the buyer after maturity.  Sure sounds like debt to me, yet Chesapeake is allowed to report them as asset sales.  What is it that makes  VPP's look so attractive when a company like Chesapeake reports them?  Unlike a normal loan which is made against cash flow, a VPP is a loan made against revenue.  VPP's are like getting a commercial mortgage based on rents instead of FFO.  Of course you can borrow more when you're guaranteeing the lender your revenues while you remain on the hook for all of the expenses and production risk.

    I'll admit that VPP's are lower risk debt because of the production profile of the wells, but it's debt nonetheless.  There's exposure to the seller in that they have to pay for all of the production expense (typically high for VPP wells), transportation, G&A, workovers, but they can't ever shut-in or suspend operations.  Do I think the use of VPP's is necessarily inappropriate, or puts the company's future in peril?  Not really.  But they are still $3.1 billion in debt instruments that management is able to hide, and the expenses associated with these deals are ongoing fixed costs (maybe $130-150 million annually) that management wont talk much about. 

    10) Management compensation is as ridiculous as any company you'll find.  The issues with Aubrey's pay are well known even outside of the energy world.  I encourage people to read the 2008 proxy cover to cover, it's filled with all sorts of goodies including Aubrey selling his $12 million map collection to Chesapeake (your capex dollars at work!), Aubrey steering events to a restaurant he owns, $1.4 million billed to Chesapeake in the last four years for Aubrey's accounting support (two words, dude: Turbo Tax), and plenty of other interesting stuff.  Did I mention he got paid over $100 million in 2008?

    What Chesapeake Has Going For Them

    My hat goes off to Aubrey in one regard - he managed to pull off one of the most one-sided JV agreements in history by selling a 110,000 Haynesville acres to Plains Exploration for $28,000/acre.  Plains should've filed a police report for getting ripped off that badly, but I guess the Kool-Aid was flowing like water at the time.  Plains needs $8.00 gas just to be breakeven on the deal.  Aubrey also executed two other JV's (Statoil in the Marcellus, BP in Fayetteville) while selling the Woodford Shale properties at high prices.  These deals were admittedly great for Chesapeake and provided desperately needed cash infusions which probably saved the company.  They also have drilling carry clauses in their JV's which mean that up until $X are spent, the partner has to put up say, 50% of the capital in order to receive a 20% interest, after which point the working interests revert back to the normal ratios.  Normally, the carries are a great deal for Chesapeake  because they earn a much better return on their investment.  Unfortunately, at current prices those reserves just aren't worth that much.  This is an extremely important point, and it's why Aubrey loves to talk about F&D while brushing aside PV10.  The sad reality is that much like selling telecom equipment in the early 2000's or selling newspapers today, producing nat gas isn't a very profitable business right now, and it might take a few years to get back to normal.  While they do  have the drilling carries, Chesapeake would be 1,000 times better off if they just received all of the money up-front in cash and paid down debt.  Through these JV's Chesapeake amazingly did show that they might sorta understand the concept of PV, although they were also under serious liquidity constraints which helped guide their behavior.

    Cash Flow Valuation

    This analysis is predicated on two macro assumptions.  First, that in 2010 gas prices hit very low levels.  Second, gas prices will probably remain low throughout the next few years as the industry goes through a painful shakeout process.

    Let's take management at their word about 2010 production growth of 8-10%.  Next year, Chesapeake will produce 900 bcf of gas (2.48 bcf/d) and 12.5 million barrels of oil (34 mbbl/d).  I am using wellhead prices of $3.00 gas and $65 oil.  They'll make $3.5 billion from production, after half of their hedges get blown up they'll make $680 million from hedging, and they'll make another $120 million from service and midstream businesses.  Assume $1.04/mcf in production expense, 3.7% of oil/gas revenues in severance tax expense, and $.41/mcf in G&A and they'll generate about $2.8 billion in EBITDA and $1.9 billion in cash flow ($2.90/share).  Every $.10 change in gas prices affects EBITDA by about $78 million.  No EBITDA multiple will save them in this case, so just valuing it at 4x cash flow, which is the historical average and very reasonable, the stock is only worth $12/share.

    On the spending side, they'll incur about $900 million in cash interest charges, they'll spend about $4.6 billion drilling wells, $260 million in seismic, $190 million in common dividends, back out $120 million in option expense, which all totals negative $2.5 billion.  So now they've got, as usual, a funding problem.  Management has already guided for $1.0-1.4 billion in asset sales, but these are highly uncertain and still wont be enough to plug the hole.  Chesapeake will be forced to tap the markets for more capital, which will crush the stock, or they'll slash their capex which means another year of no/negative growth. 

    Gas Bcf

    902

    Oil Mmbbl

    12.5

    Gas Bcfe

    903

     

     

    Gas Px

    3.00

    Oil Px

    65.00

     

     

    Oil/Gas Sales

    3,519

    Hedges

    647

    Marketing

    2,185

    Service

    200

    Revenue

    6,551

     

     

    Production

    1,014

    Severance

    128

    G&A

    406

    Marketing

    2,076

    Service

    190

    Expenses

    3,814

     

     

    EBITDA

    2,737

     

     

    Interest

    -900

     

     

    Cash Flow

    1,837

    CFPS

    2.89

     

     

    Drilling

    -4,600

    Seismic

    -260

    Options

    120

    Dividends

    -188

     

     

    FCF

    -3,091

     

     

    Shares

    635

    There is another problem here which is that Chesapeake will easily trip their debt/EBITDA covenant of 3.75:1 on their revolver next year.  They are actually very close to tripping it today, as of 9/30/09 the ratio stood at 3.48:1 and that's with the benefit of some higher prices from 9-12 months ago.  Although the banks would likely modify the covenant, it's still possible the maturity of the loan could be accelerated to be due immediately.  The banks might feel different if gas averages $3.00 throughout 2010, and Chesapeake's debt/EBITDA spikes to 5.0x. 

    Some notes about their financial reporting.  Chesapeake capitalizes about 75% of their interest so it wont screen well as being dangerously levered.  I add all capitalized interest to the income statement.  Also, debt is $1 billion higher than what is stated, as they back out the negative equity value from their converts ($2.7 billion total outstanding, the conversion prices are all much higher than the current stock price).  I calculate that as of 9/30/09, Chesapeake has $13.5 billion in debt ($460 million is preferred stock) and $520 million in cash.  The weighted average interest rate on the debt is 6.5%.

    NAV Valuation

    This analysis certainly has its merits, but it's important to understand that Chesapeake has levered up to buy non-cash flowing assets, and the value of their assets can change dramatically with changes in gas prices and investors can stop caring about the value of the non-cash flowing assets in a hurry.  When things go south, people start valuing these companies on how much they actually make rather than what their NAV is.

    Their PV10 is only 68% producing reserves, so I haircut it to avoid double counting the PUD's and the leases.  A PUD is nothing more than a low risk lease, but because of the economics and success rate of shale it really doesn't matter much what a company tells you their PUD's are, any dummy can figure it out (btw, accounting rule changes will soon allow companies to book whatever the feel like as PUD's, so people are going to start getting used to separating the PUD's from the PDP's in the NAV's).  My sensitivity is based on management's guidance that every $.10 change in NYMEX affects PV10 by $400 million (at 68% it's $272 million).  I'm using the 9/30/09 as the reference point, which reported $7.6 billion in PV10 ($5.2 billion for the PDP) at $3.30 NYMEX.  My sensitivity comes out pretty close to prior quarters of what the company has reported.  The midpoint is current NYMEX. 

      PV10 (PDP only)
    Reserves (bcfe) 3.00 3.30 4.40 5.25 6.50
    12,000 4,352 5,168 8,160 10,472 13,872

    On the acreage I do my best to account for a couple things.  First, they report their total net leasehold position, so I try to back out the developed acreage based on various data points.  Second, areas like the Marcellus are highly variable and while they report having 1.5 million acres a much smaller percent of that is worth anything.  For example, they have a ton of acreage in New York and West Virginia which is hardly worth anything at all.  Finally, I'll admit that they've got hundreds of thousands of other leases, but I just don't know how to value them, the company doesn't provide enough information.  I'm trying to only focus on the high impact plays. 

          Prices   Values
    Area Acres   Low Med High   Low Med High
    Haynesville 495   3,000 5,000 10,000   1,485 2,475 4,950
    Marcellus 1,500   700 1,200 2,000   1,050 1,800 3,000
    Fayetteville 445   1,500 3,000 5,000   668 1,335 2,225
    Barnett 198   500 1,000 2,000   99 198 396
    Colony Wash 55   1,000 1,500 2,000   198 297 396
    Granite Wash 38   2,500 3,000 5,000   95 114 190
    Total             3,595 6,219 11,157

    Here is what remains beyond reserve related assets.  It's mostly the midstream business and various equipment.

    Asset Value
    Midstream 3,300
    PP&E 1,650
    Rigs, equip 610
    Compressors 300
    Misc 540
    Investments 422
    Working Cap -2,760
    Derivatives 460
    Total 4,522

    Tie it all together and here's what we've got.  Obviously, this is a strikingly wide range of values, but even in an optimistic scenario the company is fairly valued today.  I feel pretty confident about the midpoint being the appropriate mid/long-term valuation to use because of the broken fundamentals in the nat gas market.  So either way I value this company, I think fair price is about $10/share. 

    Asset Low Med High
    PV10 4,352 8,160 13,872
    Leases 3,595 6,219 11,157
    Misc 4,522 4,522 4,522
    Cash 520 520 520
    Debt -13,000 -13,000 -13,000
    Preferred -460 -460 -460
    Equity -472 5,961 16,611
           
    Shares 635    
           
    Price -0.74 9.39 26.16

    Conclusion

    Here's how I think this plays out.  Next year gas sinks to $3.00 or less and all of the stocks get [ahem] drilled.  Shorts start circling Chesapeake for having the worst management, the highest debt, and the fewest hedges.  Analysts start to press management on why they're spending $4.6 billion on drilling (a 45% increase yoy) when gas is so low and they're losing money.  The company has a difficult time finding buyers for assets at reasonable prices, and as Aubrey's history with hedging shows he's willing to risk the entire company to get a better price on a deal.  Liquidity problems emerge as debt covenants gets tripped and we replay the events of 2008.

    So management either (a) significantly reduces the capex budget, which kills growth while still doing little to delever the balance sheet, (b) sells more assets than anticipated, and at lousy prices, or (c) issues a lot more equity to plug the gap and show some kind of deleveraging (my guess is over $1 billion, so maybe another 12-20% dilution, but who knows).   I bet you'll see a combination of all three, but in any case the stock will get killed and I think it will trade down to about $10/share, perhaps lower if there's real panic, which is entirely possible with this company...nothing would surprise me at this point. 

    The sell-side gets this stock all wrong because (a) they take management at their word about future multi-billion dollar asset sales, (b) they remain anchored to their NAV's, (c) their nat gas estimates are still too high, often well above current strip, (d) they don't properly account for capitalized interest in their CFPS estimates, and (d) Chesapeake generates millions in fees for these firms...they're a banker's dream.

    I realize a lot of this is predicated on sharply lower gas prices, so what if I'm wrong about my gas call?  Using the current strip ($5.25 average for 2010; knockouts and 3-ways stay intact), Chesapeake is still FCF negative by $1.0 billion in 2010 assuming no asset sales.  They'll generate $4.7 billion in EBITDA, which at 5.0x (this might be generous) is a fair value of $17/share.  Alternatively, cash flow per share will be about $6.00, which at 4x is $24/share.  Using 2011 strip price average of $6.15 gets you to $5.4 billion in EBITDA and $7.00/share in cash flow, for a mid-high $20's price target.  What is the upside to this stock???  Even if gas prices rally Chesapeake will always garner a valuation discount because of management and the high debt load.  The bottom line is that this company only works if gas is much, much higher, which is why in their own guidance they're forced to use $7.00 and $7.50 gas prices for 2010 and 2011, respectively.

     

    Catalyst

    Nat gas moves lower

    Equity raise

    Capex cuts

    Analyst downgrades

    Messages


    Subjectquestion
    Entry11/16/2009 02:27 AM
    Memberissambres839

    Thanks for the good report. You talk a lot about the supply equation in natural gas for 2010, but you don't talk about demand. What happens if the economy bounces back and demand bounces back? Thanks for the interesting read.


    SubjectRE: question
    Entry11/16/2009 08:11 AM
    Memberutah1009

    There's no great answer on how to predict demand, the fluctuations are driven by the economy and weather.  I think industrial demand (26%) will bounce back a little next year, but nothing spectacular.  Industrial demand has been muted for several years and didn't see a sharp rebound coming out of the 2001 recession.  Power consumption (30%) will probably grow some too, but it's hard to tell what a normal growth rate is for this because so much new CCGT plant capacity was added in recent years, mostly in the early 2000's.  Residential and commercial are mostly weather related.  NOAA is predicting a warm winter: "THE TEMPERATURE OUTLOOK FOR NDJ 2009-10 INDICATES AN ENHANCED LIKELIHOOD OF ABOVE AVERAGE TEMPERATURES FOR MUCH OF THE WESTERN HALF OF THE CONUS AND ALASKA." http://www.cpc.ncep.noaa.gov/products/predictions/90day/fxus05.html  But who knows, maybe 2010 is the coldest winter ever.

     

    Anyway, if demand does bounce back, say up 3-5%, all this will do is delay the inevitable for the producers.  Gas will rise moderately to maybe a $6.00-6.50 level for a while, companies will rejoice over these "high" prices which only allow for meager returns, and production will resume its rapid climb.  The industry can grow production a lot faster than demand unfortunately. 


    SubjectRE: RE: question
    Entry11/16/2009 12:10 PM
    Memberissambres839

    I thought I read once in an article in the FT, that 60% of natural gas production in the US was by small operators, not the big boys. Where do you get the numbers that the largest companies represent so much of the production in the US?

    Also, I would note that there has been a lot of shut ins in Canada, especially becasue a lot of the production there is by small junior companies and their access to capital has been really cut back and gotten more expensive.


    SubjectRE: RE: RE: question
    Entry11/16/2009 01:12 PM
    Memberutah1009

    Issambres, that's generally the case with US oil but not gas.  I try to account for most public companies that are remotely relevant in my analysis, which includes a few companies who are producing as little as 50-200 mmcf/d (1/10th the size of Chesapeake).  I count 39 companies whose production totals 30,600 mmcf/d, or about half of total production.  There might be another 5,000 mmcf/d coming from large integrated utilities that I haven't looked at yet.  So this comes out to roughly 60% of US production.  I have asked various energy specialists who seem to agree that 60% coming from public companies is a good ballpark figure.  Private operators have in fact cut their rig count by more than the public companies, but they tend to drill smaller wells whose production decline wont have a huge impact.

     

    Btw, the Devon call earlier today was revealing for how almost every company sees the situation.  They are going to sell all of the Gulf of Mexico and non-North America assets to focus on increasing production onshore US.  These companies are in business to grow.  The easiest path towards rapid growth is shale, in particular the high impact plays that have high IP rates.  The whole industry, not just a company or two,  has figured out how to grow production abnorrmally fast and it's going to be the death of them. 

    Company Mmcf/d 2010 2010 WA
    RDS 1,630 -11% -0.59%
    ROSE 127 -8% -0.03%
    COP 2,040 -5% -0.33%
    CVX 1,420 -4% -0.19%
    DVN 2,000 -4% -0.26%
    APC 2,144 -3% -0.21%
    WMB 1,150 -1% -0.04%
    VQ 70 0% 0.00%
    NBL 400 0% 0.00%
    XOM 1,260 1% 0.04%
    BP 2,278 3% 0.22%
    PXD 350 3% 0.03%
    XEC 310 3% 0.03%
    ECA 1,602 4% 0.21%
    BBG 240 4% 0.03%
    EOG 1,550 5% 0.25%
    OXY 653 6% 0.13%
    MRO 340 6% 0.07%
    NFX 467 7% 0.11%
    SM 190 9% 0.06%
    CHK 2,483 9% 0.73%
    APA 675 9% 0.20%
    XTO 2,420 10% 0.79%
    SD 270 10% 0.09%
    CNX 245 11% 0.09%
    RRC 370 15% 0.18%
    STR 476 15% 0.23%
    CRZO 89 15% 0.04%
    COG 265 18% 0.16%
    TLM 50 20% 0.03%
    EQT 270 20% 0.18%
    KWK 221 20% 0.14%
    NFG 75 20% 0.05%
    XCO 330 21% 0.23%
    UPL 500 23% 0.38%
    CRK 165 23% 0.12%
    GDP 83 24% 0.07%
    HK 500 37% 0.60%
    SWN 900 40% 1.18%
    Total 30,608   5.02%


    Subjectgas outlook
    Entry11/16/2009 07:05 PM
    Memberad188

    to me, macro on gas looks like this: EIA data shows demand at 60.68bcf/d. a mere 1.06bcf/d below 5yr avg (which includes 07 & 08 which had 63bcf/d of demand, ie and overheated economy) ... industrial demand is never coming back to 18 bcf/d, in fact regression to mean suggests 16ish bcf/d, and current electricity demand is being positively affected by high # of nukes offline .... worse, supply so far being maintained by current rig count (with everyone waiting for this past quarter to see demand declines), but many wells are still to be completed ... storage would be 4.5Bcf if it were unlimited, such that oversupply is 3bcf/d ... so onshore domestic gas must decrease 5bcf/d to reach full storage by nov 2010 ... depeding on views of LNG, GoM and US volumes that means a decrease of 7.5bcf/d YoY, assuming US nat gas production of 3 bcf/d to end 09 .... i dont see it, so can the US avoid shut ins 2010? is the strip being driven by liquidity and monetary depreciation fears just like everythign else?  if so, any gas company with debt is a short, unless they are integrated in some way to take advantge of a wide NGL/gas curve, like Williams...

    last week in NY the Total CEO, who has a well earned reputation for telling the truth, said that shale is a bubble, that prices paid in the JVs you mention are non-sensical, and that we are in a low gas-to-crude world for a long time to come...

     

     

     


     


    Subjectland of the blind
    Entry11/17/2009 11:30 AM
    Memberrobert511

    Since CHK management is so bad, what does that say regarding BP and Statoil management in your statement below:

    "Aubrey also executed two other JV's (Statoil in the Marcellus, BP in Fayetteville) while selling the Woodford Shale properties at high prices.  These deals were admittedly great for Chesapeake ..."

    Is it possible that CHK management is the one eyed man in the land of the blind?


    SubjectRE: land of the blind
    Entry11/17/2009 12:23 PM
    Memberutah1009

    Chesapeake was in desparate need for cash.  The fact that they were in the market to sell assets had more to do with Aubrey painting himself into a corner than being savvy.  He was not opportunistic, he was lucky.  They've raised $4 billion in upfront JV asset sales and still find themselves dangerously levered.  I have no idea what's going through BP, PXP, and Statoil's minds.  Ad188's anecdote about the Total CEO is interesting.

     

    Robert, let's say you're right, that CHK "got it" and this is the land of the blind.  If that's the case then all the more reason to short them, because none of it is sustainable.  Buyers will wake up (either because they actually see the light or they run out of money) and I'm willing to bet that JV deals with these metrics are things of the past.


    SubjectRE: RE: Cap Interest
    Entry11/18/2009 12:54 PM
    Membersag301

    if you include capitalized interest as a negative in the calculation of free cash flow, wouldn't you also have to remove the expensing of previously capitalized interest from COGS?  i.e., when they capitalize $1 of interest expense in year 2009, they are also expensing some portion of the interest that was capitalized in all prior years such as 2000, 2001, 2002, 2003, 2004, and so on.  i tried to do this but could not figure out if it was possible given the disclosures.  my own rough conclusion was that re-including the capitalized interest as a negative cash flow and then also backing out the non-cash expense of previously capitalized interest was likely a wash.  what i dont know is if previously capitalized interest is included in D&A or in cogs.  if in D&A, you would have backed it out in EBITDA.  if in COGS, then you would need to back it out.


    SubjectRE: RE: RE: Cap Interest
    Entry11/18/2009 01:43 PM
    Memberutah1009

    Sag, I'm not sure I completely follow your question.  My understanding is that they capitalize interest associated with acquiring and holding leases, then amortize that through production (depletion) or impairments (they're recorded $12.5b in impairments in the last year) or lease expirations.  The expensed interest relates more to drilling.  They aren't very clear about it.  But all capitalized interest will eventually flow through DD&A in one form or another, it doesn't show up in LOE.  It doesnt matter to me one way or another whether they decide to expense or capitalize, it's all just semantics...I care about the cash.   I ignore the DD&A completely in the analysis since they dont derive any tax benefit from GAAP DD&A and they barely pay any cash taxes, although I always have it in the back of my mind.


    SubjectNat gas articles
    Entry11/23/2009 10:14 AM
    Memberutah1009

    http://www.ft.com/cms/s/0/3ea7c35a-d604-11de-b80f-00144feabdc0.html

     

    http://us1.institutionalriskanalytics.com/pub/IRAstory.asp?tag=39

     

    Couple articles on nat gas over the weekend.  Just so I'm clear, in the long-run I agree with most commenters that the price of nat gas has to rise or service costs need to fall.  The economics at today's prices make no sense.  The problem is that the path to higher prices must first pass through a painful correction - something's gotta give.  What could happen?

     

    1) Business as usual.  Production rises despite low prices.  Gas stays low.  Stocks do poorly.  If production keeps on rising still for multiple years, stocks get killed.  This is the path we're currently on.

     

    2) Shales dont turn out to be so great like some people are now claiming.  Production eventually normalizes and gas prices rise.  Companies that rely on shale for growth are now worth a lot less as their once great assets are now revealed to be fool's gold.

     

    3) Production declines as companies are cut off from sources of capital.  Gas prices rise but now almost every company's growth rate comes down, thus hurting stocks.  But this scenario asks another question: how do sources of capital get cut off for an entire industry?  Recent examples?  Mortgage brokers/originators.  CDO managers.  Dot-coms.  In short, you need a crisis to have this happen.  So cutting off sources of new capital implies significant pain for stocks.

     

    If anyone has any ideas on how gas prices rise without going through some kind of painful correction from here I'm all ears...lord knows I've gotten plenty of things wrong before.


    SubjectSouth Africa Shale JV
    Entry11/26/2009 08:27 PM
    Memberutah1009

    On this Thanksgiving Day, 2009, I would like to give thanks to Chesapeake Energy for maintaining their predictable lack of spending discipline, thereby reinforcing my confidence in being short their stock.  Despite the fact that they will be hopelessly FCF negative for the next few years (indefinitely?) and they're woefully unprepared for another down leg in gas prices, management sees fit to embark on an international shale exploration odyssey that for all I know is being done solely to score primo World Cup tickets.  This is sure to cost millions more in overhead, acreage, exploration, legal, perhaps FX, etc.

     

    This was actually expected ever since the Statoil JV.  This is what kills me about the sell-side on CHK.  They halfheartedly bemoan Aubrey for never being satisfied with what he's got, then in the next sentence they practically beg the guy to spend money on virgin international projects that are a total mystery to us.  Anyway, this is just further evidence of the inevitable dilution that lies ahead.  What a bunch of jive turkeys.

     

    JOHANNESBURG (Dow Jones)--Sasol Ltd. (SSL) has jointly applied to explore onshore for petroleum in South Africa with Statiol ASA (STO) and Chesapeake Energy Corp. (CHK), the Johannesburg company said Wednesday.

    Exploration will focus on finding commercially recoverable shale gas resources in the Karoo Basin in the central region of South Africa, Sasol said in an emailed statement.

    The petrochemicals company said an application submitted to the Petroleum Agency SA Ltd., which is subject to approval from South Africa's government, is expected to take about 12 months.

    The Karoo Basin has unproved shale gas potential and significant exploration efforts are required to assess this prospective resource, Sasol said. Shale gas is natural gas produced from a type of sedimentary rock formed from clay and has become an increasingly important source of natural gas in the U.S. over the past decade.


    SubjectUtilities
    Entry12/03/2009 12:30 PM
    Memberround291

    I get your point that management sucks, lies, overspends, dilutes and, every once in a great while, gets lucky...and I have no comment or question on that part of your analysis.

    It's the demand picture for gas that I'm most interested, and particular attributes of electricity generators/utilities.

    Gas is a relatively clean burning fuel. At the national, state and municipal level "green standards" are being implemented that call for increased use of renewable energy sources (wind, solar etc) and a reduced carbon footprint. Nuclear is difficult to permit and takes years to come on line. Gas fired plants can come on line in, I believe, a year or so. Coal capacity is likely to be flat to decline due to carbon mandates that will come in one form or another. Southern announced closing 11 coal fired plants yesterday. Wind and solar are completely dependent on subsidies, can not provide a baseload (given the distribution/transmission infrastructure and the low capacity factors), and are feasible in a limited range of geographies. My best guess is that gas fired plants will pick up the slack and grab a larger share of electricity production.

    My understanding of electric utilities is that they pass through supply costs to consumers. They are therefore less price sensitive than other customer groups. They are also dispersed nationally with no utility representing a significant share of current gas (or other fuel) purchases. As a result they would appear to have little direct leverage on the prices charged by producers and no/or an indirect incentive to push gas prices down.

    Is it possible that Chesapeake as a large producer of low cost gas might benefit from these factors?


    SubjectA Couple of Quotes - XTO Acquisition Article
    Entry12/15/2009 09:19 AM
    Memberround291

    "These unconventional resources [shale] are going to take on an increasing role in our energy needs," said Daniel Yergin, the chairman of IHS Cambridge Energy Research Associates, a consulting firm, adding that the interest of large oil companies in shale gas was fairly recent. "This demonstrates how important natural gas is now, seen as part of the mix for a low-carbon future."

    After largely ignoring the surge in domestic resources, Washington is starting to pay attention, too, as Congress struggles to come up with an energy and climate bill that will reduce carbon emissions.

    J. Larry Nichols, the chairman of Devon Energy and of the American Petroleum Institute, said: "Regardless whether or not Congress passes any legislation regulating carbon, the underlying fact is our nation is going to need a growing amount of electricity, and natural gas is in an excellent position to capture a significant amount of that market."

    http://www.nytimes.com/2009/12/15/business/energy-environment/15exxon.html?_r=1&ref=business

     


    SubjectRE: A Couple of Quotes - XTO Acquisition Article
    Entry12/15/2009 11:35 AM
    Memberround291

    You don't look stupid...you make great points.

    You raise the right question by framing things in the context of a timeline. These sorts of transitional situations are often very attractive to me as they can create big opportunity. The question for those interested in playing this game is twofold: 1) where do you want to play along this timeline,  and the interrelated questions for those managing others money 2) what do your principals want/expect of you.

    I wish you well on this and will be watching from the sidelines.


    SubjectAny thougths on legislation against fracking
    Entry12/29/2009 07:52 PM
    Membertyler939

    There has been talk about legislative attempts to eliminate the EPA exemption for hydraulic fracking.  Utah, what are your thoughts on this?  How would CHK be effected compared to competitors, and would this be enough to derail your macro nat gas thesis?


    SubjectUtilities - The Context
    Entry12/30/2009 12:14 PM
    Memberround291

    Electric utilities project a capex spending cycle of unprecedented porportions. The planned spend, should it happen, will drive up customer rates through the impact on the rate base. States and municipalities across the country and rate setting bodies are likely to make efforts to ameliorate the impact of price increases on customers and may not allow the magnitude of spending projected by the industry. Whether or not all this spending happens, it would appear to me that many utilities will look favorably upon long term supply contracts as a means to fix supply costs, a major component of the cost to produce electricity. This would seem to me to address concerns of their rate regulators in the face of projected rate increases driven by the growth in rate base. Such a move would avoid the double whammy of growth in rate base and supply costs, which would send customer rates through the roof.


    SubjectBarnett Shale JV
    Entry01/04/2010 11:07 AM
    Memberutah1009

    TOT is entering the Barnett shale with a 25% interest in a JV.  As part of the JV, CHK sold 750 bcf of proven reserves for $800m while TOT is carrying CHK up to $1.45b on future drilling for a total pricetag of $2.25b.  Essentially, over the next 3 years, TOT will be paying 60% of the costs to receive 25% of the production/reserves.  After the $1.45b has been spent the deal reverts to a plain vanilla 25/75 split between the two companies.

     

    Up front, CHK sold PDP reserves for $800 / 750 = $1.07/mcf.  This is a firesale price, most proven reserve transactions sell for $1.80/mcf.  CHK is essentially discounting these assets by $400m.  On the back end, CHK sold future booked reserves for a premium.  Over the next 3 years, assuming the rigcount is held flat (it's going to increase, but let's just keep it simple), the JV will drill about 910 wells.  At 2.0 bcf per well and $2.6m cost per well, TOT will be spending 910 * $2.6 * 60% = $1.45b in order to get 910 * 2.0bcf * 25% = 455bcf.  So TOT is paying $3.18/mcf for wells drilled over the next 3 years.  In aggregate, TOT is therefore paying $800m + $1,450m = $2.25b for 750bcf + 455bcf = 1,210bcf.  This translates into a total price of $1.85/mcf, which is basically a normal valuation, nothing like the exceptional things that Aubrey and analysts are telling you.  It's almost 40% less than the $3.00/mcf that the street reports the deal at.  This deal highlights the cash constrained nature of CHK, as they're willing to heavily discount the up front sales in order to get cash immediately.  The PDP's were underpriced by ($1.80 - $1.07) * 750bcf = $550m.  The future reserves got a premium of about 910 * $2.6m * (60% - 25%) = $850m.  CHK therefore got an incremental $300m for signing the deal.  The deal essentially values all of CHK at $21/share by my calculations.  Admittedly, I was hoping for a lower outcome, but the stock is still overvalued and the dreams up huge upside are unfounded.

     

    Also, CHK significantly raised guidance by stating that production targets would remain the same despite selling about 7% of production.  This will be acheived through ever increasing efficiencies and more rigs.  CHK also put on more hedges, although as usual they include some trickery.  As best I can tell right now, what they did was put on collars (selling a high call, buying a low put).  But the hedge price they reported is impossibly high.  What they're doing is taking the premium from the calls, netting it out against the cost of the puts, then using that figure to tell us what the "hedge" price is.  It's aggressive.  I will need more details on what they've been doing.

     

    Overall this helps CHK, but not in a giant way.  Rather than pay down debt they jack up production and keep spending money.  People were cautious on the call about what this spells for the nat gas market, as they should be.  At some point it's going to catch up to these companies in a major way.


    SubjectRE: Barnett Shale JV
    Entry01/07/2010 04:21 PM
    Memberjessie993

    Just read your initial pitch. Very interesting and impressive analysis. Regarding your last message, how do you get to the $21/share implied valuation based on the Total deal?


    SubjectRE: EIA 914 Data - Nov
    Entry01/29/2010 03:57 PM
    Memberround291

    Utah,

    Can you explain why an increasing rig count necessarily portends for some sort of a "violent shakeout"? It may sound like an elementary question but I'd like your thoughts. And what does "violent shakeout" mean to you?

    At bottom I'm wondering whether there is, in your mind, any scenario where more rigs and supply is potentially a good thing, or even a push, for this company?

    For the purposes of full disclosure, I own some CHK though a fund I'm in that I've been considering dropping, largely because the fund management's rhetoric with respect to importance of its evaluation of company management doesn't seem to match up well with some of the investment decisions it has made. There's no doubt that the McClendon stuff is odious...


    SubjectRE: Haynesville economics
    Entry02/08/2010 03:19 PM
    Memberrasputin998

    Hi Utah -

    Would you mind sharing your list of shorts once you have put on your positions for those of us who buy into this thesis?

    Thanks,

    R.


    SubjectRE: Q4 and mpk reply
    Entry02/23/2010 01:14 PM
    Membermpk391

    Utah, thanks for your reply.  Berman actually came out with a somewhat-similar piece on the Haynesville right around the same time as Dell, thus my confusion in thinking they were co-authors.  You can find Berman's piece here: http://www.theoildrum.com/node/6229#more

    Note that his previous analysis was on the Barnett, and he hasn't extrapolated anything to arrive at conclusions about younger plays like the Fayetteville, et al. (except - obviously - the Haynesville). 

    I agree he could be overstating the problem in that his focus is on EURs and not NPV, payback time, etc.  The extremely short half-lives of many shale gas wells mean those latter metrics might not be terrible even if EURs are way too high (due to assumptions about the tails and economic limits of the wells). 

    ... but still, I find it interesting that he has caused such a stir in the E&P community.  Note the drama at World Oil Magazine, rebuttals from Tudor Pickering Holt et al.  Sometimes I think anything that draws this much ire has got to have some truth to it - otherwise he'd just be quietly dismissed as a cracked-pot and ignored.  Let's not forget that pretty much all the players have a financial incentive to keep this shale thing going.  I'll further note that I have yet to read a convincing rebuttal. 

     

    LNG

    Glad you mentioned this ... it's the other concern weighing on my mind re: gas prices.  I think the NA gas market sort of forgot about this risk for a while due to various external factors (the shut-down of 7 nuclear reactors in Japan plus high oil prices) which alleviated the need to dump unwanted gas into the U.S.' vast storage capacity. 

    The bear case seems simple: we're using only about one out of our 10 bcfe/d of re-gas capacity and the very high liquids content of these new LNG trains means they could dump the gas on the U.S. at a landed price of $0 and still not lose money.  So if Europe/Asia demand ever tanked it's all coming our way.

    But lately I read that global re-gas capacity is actually growing faster than liquefaction capacity.  So wouldn't that help to alleviate the problem?  What do you think?

     

    All I know for sure right now is that the pricing dynamics for NA gas have significantly changed from what they were in the 2003 - 2008 timeframe and thus I've had to rethink my strategy.  I used to hope for bargains, now like you I'm looking to buy puts.


    Subjectsome Haynesville data...
    Entry02/25/2010 10:08 PM
    Membermpk391

    My apologies for previously posting a link to the wrong A. Berman presentation.  I don't have his most recent version (but see synopsis here: http://seekingalpha.com/instablog/345817-eamon-keane/55447-new-research-questions-haynesville-economics

    However,  I did come across what I think is an earlier (Oct '09) version here: http://www.lgsweb.org/Shale.pdf

    Haynesville discussion starts on Slide 24.


    SubjectGazprom/LNG
    Entry03/03/2010 01:56 PM
    Membermpk391

    FYI, earlier this week Gazprom announced a major shift in gas pricing, allowing up to 15% of sales to Europe to be made at spot prices (which have been lower than its normal fixed contract prices which are based on the cost of oil  - I guess they had to respond to all the new (lower cost) LNG that has been arriving in European ports).  It remains to be seen whether or not some of those ships will now head to the U.S. instead, but it is certainly a risk for CHK et al.


    Subjectmanny, could you elaborate re: xco
    Entry03/23/2010 10:49 PM
    Membertyler939

    The CEO's statements in particular?  Thanks.


    SubjectRE: RE: manny, could you elaborate re: xco
    Entry03/24/2010 03:14 PM
    Membertyler939

    Thanks.  reading your writeup now


    SubjectRE: RE: RE: Some Questions
    Entry03/24/2010 05:46 PM
    Membertyler939

    Manny, I agree that $1 billion seems possible for 50% of XCO's Marcellus acreage, since that's around $12,000 per net acre for the 170,000 net acres XCO holds, a valuation similar to that of the Anadarko/Mitsui Marcellus JV.  The analysts I've spoken with are using valuations around $9,000 per acre, so an extra $3,000 per acre above current expectations would be worth $500 million, or around $2.40 per share, which gets us to a share price around $21.00.  How do you see a $2 billion valuation taking XCO up to $25?

    If you'd rather reply on MJS77's XCO writeup, I'm watching that, too (BTW, MJS puts the value at around $8,100 per net acre).


    SubjectRE: RE: RE: RE: Convertible preferred
    Entry05/16/2010 09:37 PM
    Memberjaxson905
    There is a real issue brewing as to whether the market can absorb all these "liquids" plays the E&Ps are going for.  The reality is the majority of the liquids production isn't oil but instead is natural gas liquids (NGLs).  NGLs are a domestic only market (no exports) and are almost entirely used by the petrochemical industry.  Historically these have traded relative to oil (around 60%) but as this supply ramps that relationship is going to disconnect.  There is only so much demand for these NGLs and the U.S. petchem industry is running highly utilized with limited new capacity on the horizon. 

    SubjectRE: RE: RE: RE: Couple Thoughts
    Entry05/25/2010 02:09 PM
    Memberchuck307
    CHK is not more levered yet because it has cash offsetting the incremental debt (e.g., raising $1 billion of cash via debt doesn't create net debt).  Now, give Aubrey time to go Create Value with that cash, and CHK will be more levered.

    SubjectRE: Question/Comment on convert
    Entry05/29/2010 12:22 PM
    Memberad188
    i see it the way you do, and Aubrey's bankers deserve credit for scouring the world for new capital -- such are the joys of excessive leverage...

    SubjectRE: RE: RE: Reserve upgrade
    Entry08/16/2010 06:09 PM
    Memberjaxson905
    You see he spent another $750mm on leasehold in July (10-Q p. 41).  The numbers are really out of control:
    1H 2010
    OCF:  $2.3b (excluding proceesd from W/C reduction)
    Capex before any leasing:  $2.9b
    Net leasing:  $1.6b
    So total capex = $4.5b vs. $2.3b in OCF.  And he just spent another $750mm in July...

    SubjectBuyside interest
    Entry08/31/2010 10:01 AM
    Membersea946
    It seems like a consensus has built on this board that the clueless sell-side loves CHK while the buy-side hates it.  I'm not sure I take this conclusion at face value.  Mason Hawkins owns 12% of the company and didn't sell any in Q2 (even added a bit).  Also in Q2, Boone Pickens doubled his position, while Carl Icahn took his stake from 2 million to 12 million shares.  These three guys are neither clueless nor fall easily for management hype.

    SubjectRE: RE: RE: Buyside interest
    Entry08/31/2010 01:32 PM
    Memberjaxson905
    I listened to Mason Hawkins presentation on CHK (in OID recently) and, with all due respect to him as a good investor, his logic here doesn't hold.  Aubrey likes to tout how he bought his shale acreage for $3 billion and sold it for $11 billion in 2008/2009 and Hawkins threw out that same statistic.  The problem is that there's no accounting in that analysis for the billions that CHK has wasted chasing acreage (in Q1 2009, they took a $10 billion impairment on their various acreage positions).  That's the equivalent of me taking $100 to the slot machines, losing $90 of it and then having $10 hit with a $20 payout...and then holding that up $30 and saying "Look, I made 3x my money!"
    In 2007-2008, CHK spent $27.5 billion buying acreage and drilling.  I would have hoped they had something to show for that.  Also look at the cash flow in 1H 2010 - they hoard acreage and sell it down but somehow never manage to delever the business or generate any positive cash flow. 
    The problem here is the business model.  It's premised on a greater fool theory that you can massively overpay in a commodity business and as long as you'll have a major who will pay more then it will prove to be a smart investment.  In 2008 when Aubrey did the bulk of his JVs, shale was a totally novel concept (majors recognized they were behind the curve) and gas prices were > $10/mcf.  It's no surprise then we was able to monetize at those kinds of values.  Today the environment is very different.  I think it's very dangerous of guys like Mason Hawkins to bet that he can keep doing it with a balance sheet as leveraged as his.
    Also note the litany of reserve engineering firms that CHK uses, very odd for a large cap company (most will typically have just 1 and it will be one of the big 3). 
    This whole "pivot to oil" is funny in its own right - unfortunately CHK is the largest gas producer in the country and the most leveraged to gas of any E&P (7% of production is liquids).  Go to their website - "America's Champion of Natural Gas" is the title.  Their fate is tied to gas unfortunately for them and now we are swimming in it. 

    SubjectRE: RE: RE: Liquids/JVs
    Entry09/30/2010 07:55 PM
    Memberpathbska
    Btw, on the golf balls, the best part is they were rebranded to each one of their 4 major shale plays (Haynesville, Marcellus, Barnett and Fayetteville)...wonder what they are going to put this year...Granite Wash, Niobrara, Eagle Ford, Ghawar?!?

    SubjectRE: RE: RE: RE: Liquids/JVs
    Entry10/01/2010 02:26 PM
    Memberjaxson905
    At the very least I was glad to see that they changed their website - it used to read "America's Champion of Natural Gas" or something to that effect. 
    The bottom line in my view is that this whole company is built on nat gas - its 93% of production and all of the resource/acreage he has is around natural gas.  CHK produces 5% of all the gas in the country (largest gas producer).  He talks about all the billions of barrels of oil potential he has that popped on his balance sheet out of nowhere in 2010 but i don't know how he concludes that after having drilled a handful of wells - as it stands now its just acreage and a dream. 
    In the last 3 months, the 2011 strip has fallen from $5.50 to $4.40 and seems to be headed lower.  The horizontal rig count meanwhile keeps heading up.  By my math, a $1.00 move in long-term gas prices cuts ~$10/share off proved NAV.  Given that the market has shot the better run high-multiple growthy E&Ps (RRC, SWN, etc) I don't know how CHK is going sustain its current price.  I think there have been a lot of speculative buys in advance of the meeting next week and the well-telegraphed Eagleford JV deal but unless he's got more to offer then I think that will be the peak. 

    Subjectso who has the "good" eagle ford shale
    Entry10/11/2010 10:21 AM
    Membertyler939
    Is there a  pair here?

    SubjectRE: RE: A couple of questions
    Entry10/14/2010 04:51 PM
    Memberlys615
    Utah,
    This isn't specifically a CHK question, but since this is an active thread, we'd enjoy your take.  We agree with you that the economics of these JVs certainly seem outrageous from the standpoint of the foreign money.  They obviously have other motivations besides just IRRs.  So, what does this do for the industry?  Historically, a lengthy period of low gas prices would have induced less drilling activity.  But, if CNOOC, et al is willing to write a check for $1B along with another $1B check to fund capex, this would seem to keep drilling activity artificially high (and kick the can down the road for guys like Aubrey).  Given that the Chinese likely won't waste their time doing similar deals with smaller players, does this create a competitive disadvantage for smaller operators who can't get uneconomic capital to keep them going?  All of these conference presentations seem to have the slides about how the market values these particular mcf too cheaply, etc.  However, if you can sell to CNOOC, then perhaps you do get a different valuation because they'll overpay.  Not sure we're communicating this very well... the bottom line -- have the economics of this industry been altered materially by the uneconomic foreign money in a way that disadvantages the smaller producers?  Should smaller players even exist?
     
    Thanks.

    SubjectRE: RE: RE: RE: A couple of questions
    Entry10/14/2010 06:38 PM
    Memberjaxson905
    If you look at what happened to the LOE of PXD after they did their VPPs (did a bunch in the 2005/2006 timeframe), it killed the unit costs by driving them up.  The accounting works that the revenue and production go away but the costs stay - so definitionally your LOE should be going up.   This is the big reason that other public companies (other than CHK) don't use them - generally the market is limited to private/small companies that don't have access to attractive financing.  For a public, the name of the game to wall street is to be low cost - and VPPs increase your unit cost structure, so they are generally avoided. 
    CHK is playing games some how to avoid the impact of this, I'm just not sure what they are doing beyond capitalizing the incremental opex. 

    SubjectRE: RE: A couple of questions
    Entry10/14/2010 06:43 PM
    Memberjaxson905
    I would push back on your claim he's doing the right thing.  Yes he raised $1.1b from CNOOC but he spent $750mm in July alone on leases and the lease spend this year is going to be almost $5 billion!  (btw they said at last year's analyst meeting that it would be $500-600mm).  Selling VPPs isn't asset sales - it's a sale/leaseback (i.e. off balance sheet leverage). 
    He's also issuing huge amounts of equity to do it, what's the net impact to value/production per share?  Over time the company has been one of the lowest performers on this metric which is why the stock has been an underperformer. 
    The strategy is flawed - he wins land by overpaying for it and the business strategy is hoping he can flip it to someone else at an even higher price. 
    Like I noted in an earlier post, yes he monetized a big chunk of his gas shales in 2008/2009 and got $8b or so, but he also had to take a massive impairment for all the bad acreage he had bought (I forget the exact number it was > $9 billion in Q1 09).  So what's the net value creation there?  You bought the acreage for $3b and sold it for $9b ($6b net gain) but then wrote off another $9b elsewhere. 

    SubjectRE: RE: RE: A couple of questions
    Entry10/14/2010 07:00 PM
    Memberlys615
    We completely agree that CHK's strategy is flawed.  If that's true, then one would assume that someday the capital would be taken from Aubrey given the likelihood of him destroying it.  We're wondering if uneconomic buyers are altering this dynamic materially, and specifically is that changing the future economics for smaller players who may be required to wait out lower gas prices for a longer time given that CNOOC, or whomever, won't likely write a big check on the same type of terms to smaller players (here, we are assuming that $4 gas doesn't generate economic value over time -- others may think differently)?
     
    Put another way, are the long term economic profits falling for many smaller industry participants given the entrance of capital providers on uneconomic terms to larger players?  

    Subjectdevil's advocate on cnooc JV
    Entry10/18/2010 11:41 PM
    Memberjessie993
    looks like a very good deal for chk and hard to see cnooc earning an acceptable return but to play devil's advocate: $2.2bln/35mmboe is $60k per potential flowing bbl. If you had a very, very low cost of capital, then you can pay what looks like an outrageous price versus someone who has a "market" cost of capital. thoughts?

    SubjectRE: RE: devil's advocate on cnooc JV
    Entry10/21/2010 06:07 PM
    Memberjessie993
    thats just amazing. i thought it was $2.2bln including the carry!!  whats another $1bln for a play that will disappoint. 

    SubjectRE: Update - earnings, nat gas, misc
    Entry11/04/2010 12:39 PM
    Membertyler939
    Thank you for the timely updates.  Can you recommend any way to play this dynamic other than CHK?  As has been previously noted, If Aubrey can keep signing non-economic deals, this may take a while to play out.

    SubjectRE: Update - earnings, nat gas, misc
    Entry11/05/2010 09:27 AM
    Membersea946
    I find it interesting that as value investors, we are proclaiming the "death knell" for natural gas here after UNG is already down some 90% since mid-2008.  Where were the calls of a death knell back then?  The call now just feels more like psychological capitulation than anything else.  Maybe we are actually near a bottom for natural gas?
     
    This is interesting because we are not talking about newspapers here.  We are not talking about video rental.  We are talking about a major energy commodity at a time when the world is increasingly starved for energy.  Natural gas actually has an energy content that provides a fundamental relationship between gas and oil (six mcf equals one boe).  Don't you think the demand side of the equation will start changing at some point if oil is 3+ times more expensive than natural gas when the energy content is considered?  What about the environmental advantages of gas?  What about energy independence?
     
    In my mind, there is no doubt consumption of natural gas will increase big-time if prices stay where they are.  It is only a matter of time -- which makes this a cyclical commodity rather than an obsolete commodity.  Maybe some here believe that prices will stay low even if demand grows in a big way, due to "technology."  Well, I say great, the world will be a much better place if we can have unlimited quantities of North American natural gas at $4 or less per mcf.  We will have solved many existential problems if "technology" can suddenly make energy plentiful, domestic, environmentally friendly, and cheap.  I'll be happy to lose on my long investment in natural gas!  But will this utopia really happen?

    SubjectRE: RE: RE: Update - earnings, nat gas, misc
    Entry11/08/2010 04:52 PM
    Memberjaxson905
    I think the issue for natural gas is simply one of supply and demand. 
    Demand will ultimately start to accelerate but when you look at where that is going to come from (power gen and transportation), it's a very long process b/c it involves major infrastructure changes.  On power gen, any coal that could have switched to nat gas already has.  So going forward, when there is power growth, underutilized gas plants will first fill that (and then new plants built could be gas although the major push on renewables may add enough capacity to fill this new demand for multiple years).  On transportation, if the US gov't ever got behind the Pickens Plan that would be great for nat gas but it would be years before we had any CNG trucks or vehicles on the road. 
    On the supply side, we now know there is endless supplies of nat gas in the US and that these supplies will be drilled at $4.50 or higher gas (look at the presentations of any of these E&PS and then drill into the well economics for the key shale plays). 
    Given those two dynamics, its hard to see any sustained tightness in nat gas, and even if it happens for a brief period of time, what will investors capitalize in stock prices knowing that a wave of shale gas will arrive 3-4 months later? 

    SubjectRE: Cover of Sunday NYT
    Entry06/26/2011 05:28 PM
    Membersugar
    Thank you for posting this. I researched this topic extensively after seeing Berman's presentations. There are analytical flaws with Berman's approach.  But there is also some truth to it. Tudor Pickering published a refutation a year or so back, which also had analytical flaws.
     
    Has anyone else done independent research into this subject? I think it is definitely worthy of discussion, as it impacts potential shorts in the space (SWN, CHK, XCO, ECA) as well as potential longs (DVN, CHK, SD and others). And it could have a broader economic impact - if shale gas is really uneconomic, it makes the US an even less competitive place for manufacturing, chemicals and other industries in the long run.

    SubjectRE: RE: Cover of Sunday NYT
    Entry06/26/2011 08:39 PM
    Memberflow123
    utah has made excellent points regarding McClendon's shortcomings and potentially CHK's overstating of reserves, etc.  That being said, I don't think this New York Times piece shed any light on the situation.  It is widely believed that the cost of shale gas production is above current prices and is somewhere in the neighborhood of $5 (varies by play).  To publish a piece that suggests that, after reviewing internal emails and well performance data, there is suddenly some revelation that the "drilling treadmill" is a Ponzi scheme is just bad journalism IMO.  The big players in the industry hedged through the cycle -- and thus drilled through the cycle -- and, seeing that their hedges will eventually roll off and the economy is still weak, have diverted huge amounts of capex to NGL and oil production.  Almost everybody thinks shale gas is uneconomic at $4.  Nothing new there.  TPH estimates the breakeven price to be close to $5 as I recall.  Some plays, such as the Marcellus, have lower breakevens.
     
    Now the point about overstating the life of the wells, reserves, etc is well put. 

    SubjectRE: RE: Cover of Sunday NYT
    Entry06/26/2011 11:38 PM
    Memberthrive25
    ad188 - Could you share an elevator pitch on FST as a short? tia

    Subjectquestion for utah
    Entry11/05/2011 10:14 PM
    Memberjessie993
    utah,
    id be curious what you would do if you were aubrey

    SubjectRE: CHK lost decade
    Entry11/05/2012 12:51 PM
    Memberjso1123
    utah - further to your thoughts (which I agree with), when I look into 2013 they are going to need to sell another say ~$4b to cover the deficit - but is left to sell?  All the easy stuff (midstream) is gone and they are now selling their liquids plays (Permian, Miss Lime, Eagleford selldown).  Outside of the Miss Lime, all of their core plays are JV'ed already - Marcellus, Eagleford, Haynesville, Utica wet, Niobrara, Barnett...there's nothing left to JV.  So stage two is to start selling your ownership interest in existing JVs, either to existing partners or to new players (assuming the terms of the JVs allow this).  This will likely occur at below market pricing for obvious reasons.
     
     
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