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CCHHEESSAAPPEEAAKKEE EENNEERRGGYY
CCOORRPPOORRAATTIIOONN
GGRRIIFFFFIINN CCOONNSSUULLTTIINNGG GGRROOUUPP
James Lambert
Jason Blauvelt
Prabhava Upadrashta
Monday, April 02, 2012
2
CONTENTS
Executive Summary ..................................................................................................................... 4
Overview and History ................................................................................................................. 5
Financial Analysis ........................................................................................................................ 8
Recent Financial Performance ................................................................................................ 8
Consolidated Balance Sheets (USD $ In Millions) ............................................................... 9
Consolidated Statements Of Operations (USD $) In Millions ......................................... 11
Consolidated Statements Of Cash Flows (USD $) In Millions ........................................ 13
Production Data ..................................................................................................................... 16
Industry Comparison ............................................................................................................ 18
Financial Indicators: Seven Largest Domestic Natural Gas Producers .......................... 18
Stock Price and Analyst Opinions ....................................................................................... 19
Price: Chesapeake vs. S&P 500 ............................................................................................. 20
U.S. Natural Gas Wellhead Price (Dollars per Thousand Cubic Feet) ........................... 20
Competitive Analysis ................................................................................................................ 21
Internal Rivalry ...................................................................................................................... 21
Entry Threat ............................................................................................................................ 22
Buyer Power............................................................................................................................ 22
Supplier Power ....................................................................................................................... 23
Substitutes ............................................................................................................................... 23
Complements .......................................................................................................................... 24
SWOT Analysis .......................................................................................................................... 24
Strengths .................................................................................................................................. 24
Weaknesses ............................................................................................................................. 25
Opportunities.......................................................................................................................... 26
3
Threats ..................................................................................................................................... 27
Strategic Recommendations ..................................................................................................... 28
Shift production towards oil ................................................................................................ 28
Improve the balance sheet .................................................................................................... 28
Invest in natural gas technologies ....................................................................................... 29
Lobby Congress to implement pro-natural gas regulations ............................................ 30
Encourage the development of export capabilities ........................................................... 31
Endnotes ...................................................................................................................................... 32
4
EXECUTIVE SUMMARY
Over the past five years, Chesapeake Energy has doubled its production of natural gas
and oil and grown into the second largest producer of natural gas in the United States.
The company has also established itself as an expert in unconventional drilling
methods, such as hydraulic fracturing and horizontal drilling, which allow it to reach
deposits that were previously uneconomical.
However, as a natural gas extractor, the success of Chesapeake Energy’s business is
highly dependent on natural gas prices. Plummeting prices since 2008 have ensured
that even with operational expertise and the rapid expansion in production,
Chesapeake has been met with only limited growth in revenue and profits. At the same
time, the firm has seen its balance sheet deteriorate because of the debt it has taken on
to finance its expansion.
Despite these frustrations, Chesapeake can put itself in a position to succeed in the
years to come. To do so, it must accomplish several things: First, it must restructure its
operations to better manage the current environment of low natural gas prices. By
shifting its balance of production away from natural gas and towards oil in the short
term, Chesapeake can earn a higher return on its invested capital and also further
diversify its sources of revenue.
Second, Chesapeake must improve its balance sheet. Cost management is
particularly important in a commodity based industry such as natural gas extraction. By
reducing the amount of debt the company is carrying and improving its liquidity,
Chesapeake can lower its financing costs. The firm should divest existing assets and
enter into more joint ventures in order to accomplish this objective.
Third, Chesapeake needs to invest in opportunities that will stimulate domestic
natural gas consumption. Emerging natural gas technologies, particularly in the ground
transportation industry, are becoming increasingly economical as prices stay low. By
accelerating the development of these technologies, Chesapeake will stimulate demand
in the long term. Chesapeake should also leverage natural gas’s status as the cleanest
carbon fuel to promote pro-natural gas environmental legislation.
5
Finally, Chesapeake must encourage the development of liquefied natural gas
infrastructure that will allow for large scale export of natural gas. Currently there are
enormous disparities in prices in different regions of the world, and overseas export
capacity is limited. As more LNG transport capacity is developed, relatively low prices
in the United States will rise, to Chesapeake’s benefit.
OVERVIEW AND HISTORY
Chesapeake Energy is the United States’ second largest producer of natural gas, and
also a top 15 producer of oil and natural gas liquids. The company is headquartered in
Oklahoma City and has 12,600 employees. In 2011, Chesapeake recorded revenues of
$11.6 billion and an EBITDA of $4.45 billion1. Chesapeake’s main business strategy
centers on natural gas extraction from unconventional sources. This broad category is
used to describe natural gas deposits that had been difficult or uneconomical to remove,
including those that are especially deep, near impermeable rock formations, or located
in shale. Chesapeake uses a variety of techniques in its extraction, including horizontal
well drilling and hydraulic fracturing.
Chesapeake was founded in 1989 by CEO Aubrey K. McClendon and former
President and Chief Operating Officer Tom L. Ward, who sought to employ emerging
technologies to establish a natural gas exploration and production firm. The duo, in
private partnership since 1983, had both graduated from college less than a decade
earlier at the peak of the oil boom. McClendon and Ward began with just ten
employees and a $50,000 initial investment, looking to seize on a strategy of horizontal
drilling. By concentrating on drilling and developing horizontal natural gas wells in
unconventional reservoirs, the young company built significant positions in the Golden
Trend and Sholem Alechem fields of South-central Oklahoma and in the Giddings field
along the Gulf Coast.
Propelled by its initial success, the firm increased production and grew its reserves
rapidly. McClendon sought funding for continued growth, and as a result, Chesapeake
6
completed its IPO at a split-adjusted price of $1.33 per share in February of 1993. The
firm debuted on the NASDAQ, but would later move its shares to the NYSE, listed as
CHK.
Following an important natural gas discovery in the Deep Giddings portion of the
Austin Chalk formation in Southeastern Texas (in 1994), the company began another
wave of enormous growth. Between 1994 and 1996, the firm had the highest growth rate
in the industry2, and continued its widespread use of horizontal drilling and innovative
geological assessment techniques.
The successes wouldn't last however, as attempts to extend the Austin Chalk
investment from Southeastern Texas along the Gulf Coast into Western and Central
Louisiana failed. High drilling costs and unanticipated geological and engineering
challenges doomed the project's continuation into Louisiana. The coinciding collapse of
oil and natural gas prices to their lowest levels in twenty years compounded the firm's
woes, forcing the firm to reconsider its strategy.
On the heels of operational disappointments and a commodity price collapse, the
firm sought to reinvent itself, rediscovering its roots in Oklahoman natural gas. The
company revised its strategy, focusing almost exclusively on natural gas production,
and largely abandoning the Austin Chalk for a return to Oklahoma. The new focus
centered on using the newest technologies to discover new reserves, and to target a
more diversified, longer reserve life and lower risk asset base. For the first time, the
firm began to incorporate growth by acquisitions into its business plan.
Spearheaded by its new strategy, the firm rekindled its earlier growth, expanding its
production and presence through a balance of acquisitions and new drilling. Owing in
part to tightening supply, natural gas prices began to rise, accelerating all the way
through 2007. Recognizing that rocketing prices paired with improvements in
horizontal drilling and completion technologies would enable the industry to develop
monumental new supplies of natural gas from unconventional reservoirs, Chesapeake
expanded its land positions to include fractured carbonates, tight sandstone and shales,
such as the Barnett, Fayetteville, and Marcellus shales. The commitment to horizontal
drilling and exploring unconventional reservoirs proved successful, and Chesapeake
began to transform the industry itself, as others began to abandon the increasingly
7
elusive and expensive search for undiscovered conventional natural gas reserves. The
firm's foresight led to its installation as one of the nation's largest natural gas producers,
and in 2006 Chesapeake was added to the S&P 500, displacing Dana Corporation.
In 2008, Chesapeake announced its discovery of Haynesville shale in East Texas and
northwestern Louisiana. This breakthrough is expected to play a major role in the
firm's future, as Haynesville shale is now projected to become the nation's largest
natural gas producer by 2015. In addition to turning its attention towards developing
and drilling fields in these and other areas, the firm now seeks to incorporate
unconventional liquids-rich reservoirs, having invested nearly $4.7 billion in 2010. The
transition towards liquids-rich wells has already begun, with approximately 30% of
drilling and capital expenditures in 2010 allocated to liquids-rich plays, compared to
10% in 2009 and a projected 75% in 2012.
The company currently holds interests in over 45,700 productive wells positioned on
15.3 million net acres of drilling land. It is the most active driller of new wells in the
United States, with a working interest in almost 3,000 new wells over the past year. In
2011, Chesapeake produced approximately 1.2 trillion cubic feet of natural gas
equivalent (tcfe), 84% of which was in the form of dry natural gas and 16% of which
was oil and natural gas liquids. The company holds an estimated 19.9 tcfe in proved
reserves. As such, Chesapeake represents a significant percentage of both the United
States’ total natural gas production (4.3%) and its proved reserves (5.7%).3
Production is divided into regional divisions. The Southern Division is composed
mostly of natural gas plays in the Haynesville, Barnett, and Bossier shales in Texas and
Louisiana. These are Chesapeake’s most significant holdings as they account for 47% of
total production and 43% of proved reserves. The Northern Division holds interests
across Oklahoma and northern Texas, including the Anadarko Basin. Chesapeake’s
Eastern division primarily consists of the Utica Shale in Ohio and Western
Pennsylvania, as in December 2011 Chesapeake sold most of its holdings in the
Marcellus Shale. The Western Division spreads across West Texas, New Mexico,
Colorado, and Wyoming. Major plays include the Permian and Delaware Basins, the
Eagle Ford Shale, and the Rocky Mountain/Williston Basin.
8
Chesapeake is vertically integrated and has several affiliates and subsidiaries that
help bring its product to market. Chesapeake Energy Marketing provides price
structuring and contract administration services to for Chesapeake and its buyers. Two
midstream companies, Chesapeake Midstream Development and Chesapeake
Midstream Partners, provide pipeline infrastructure and are involved in compressing,
processing and treating natural gas. Chesapeake NG Ventures, formed in 2011,
identifies and invests in technologies that will increase demand for natural gas.
Chesapeake also owns companies that provide drill site service and equipment
Chesapeake also participates in several joint ventures wherein the company sells a
minority interest in its leasehold on certain wells in order to offset some of its capital
costs. The company’s partners in these plays are largely multinational petroleum
companies such as China National Offshore Oil Corporation, Total S.A., and British
Petroleum.
FINANCIAL ANALYSIS
Chesapeake’s current financial situation is a major weakness that management must
address. The company has been able to rapidly expand both its holdings and
production in recent years, and its relatively high gross profit margin indicates that it is
able to operate more efficiently than its competitors. However, falling natural gas prices
have limited the revenue and earnings gains from these activities. Moreover,
Chesapeake is currently highly levered with debt and has issues with liquidity.
RECENT FINANCIAL PERFORMANCE
Over the past five years, Chesapeake’s total asset value has grown at a 6.4% CAGR from
30.7 to 41.8 Billion dollars. Over 85% of the value of these assets is either in the form of
the property that the firm holds leases on or the equipment used in extraction.
Chesapeake stands to benefit significantly if it can divest or otherwise monetize some of
these property and equipment assets and use the proceeds to reduce debt.
9
Chesapeake is currently highly illiquid. At year-end 2011, the company’s current
ratio was only .45, down from 1.18 in 2008. This indicates that Chesapeake may have
problems meeting its short term debts.
The firm has used a large amount of debt to finance its rapid growth and as a result it
is highly levered. Its debt to equity ratio, when defined as total liabilities over total
equity, is 1.33. Chesapeake also carries $10.8 billion in interest-bearing long term debt,
which represents .64 of total equity; this is considerably higher than the industry
median of .44. It has been successful in recent years in reducing the scale of this
obligation, but it has also seen current liabilities increase greatly over the same period.
CONSOLIDATED BALANCE SHEETS (USD $ IN MILLIONS)
Dec. 31,
2011
Dec. 31,
2010
Dec. 31,
2009
Dec. 31,
2008
Dec. 31,
2007
CURRENT ASSETS:
Cash and cash equivalents $351 $102 $307 $1,749 $1
Accounts receivable 2,505 1,974 1,325 1,324 1,074
Short-term derivative assets 13 947 692 1,082 203
Deferred income tax asset 139 139 24 0 0
Other current assets 125 104 98 137 118
Total Current Assets 3,177 3,266 2,446 4,292 1,396
PROPERTY AND
EQUIPMENT:
Evaluated natural gas and oil
properties 41,723 38,952 35,007 28,965 27,656
Unevaluated properties 16,685 14,469 10,005 11,379 5,641
Natural gas gathering systems
and treating plants 1,763 1,545 3,516 2,717 1,135
Other property and equipment 4,858 3,726 3,235 2,609 1,312
Total Property and Equipment,
at Cost 65,029 58,692 51,763 45,670 35,744
Less: accumulated depreciation,
depletion and amortization (($6)
and $0 attributable to our VIE) -28,290 -26,314 -25,053 -12,362 -7,407
Total Property and Equipment,
Net 36,739 32,378 26,710 33,308 28,337
LONG-TERM ASSETS:
Investments 1,531 1,208 464 701 616
10
Other long-term assets 388 327 294 288 385
TOTAL ASSETS 41,835 37,179 29,914 38,593 30,734
CURRENT LIABILITIES:
Accounts payable 3,311 2,069 957 1,611 1,262
Short-term derivative liabilities 191 15 27 66 174
Accrued interest 183 191 218 167 175
Other current liabilities 3,397 2,215 1,486 1,777 1,150
Total Current Liabilities 7,082 4,490 2,688 3,621 2,761
LONG-TERM LIABILITIES:
Long-term debt, net 10,626 12,640 12,295 13,175 10,950
Deferred income tax liabilities 3,484 2,384 1,059 4,200 3,966
Long-term derivative liabilities
($10 and $0 attributable to our
VIE) 1,541 1,693 787 111 408
Asset retirement obligations 323 301 282 269 236
Other long-term liabilities 818 407 462 200 283
Total Long-Term Liabilities 16,792 17,425 14,885 17,955 15,843
STOCKHOLDER'S EQUITY:
Preferred stock 3,062 3,065 466 505 960
Common stock 7 7 6 6 5
Paid-in capital 12,146 12,194 12,146 11,680 7,032
Retained earnings 1,608 190 -1,261 4,569 4,150
Accumulated other
comprehensive income (loss) -166 -168 102 267 -11
Less: treasury stock, at cost;
1,552,533 and 1,221,299 common
shares -33 -24 -15 -10 -6
Total Chesapeake Stockholders'
Equity 16,624 15,264 11,444 17,017 12,130
Noncontrolling interests 1,337 0 897 0 0
Total Equity 17,961 15,264 12,341 17,017 12,130
TOTAL LIABILITIES AND
EQUITY $41,835 $37,179 $29,914 $38,593 $30,734
Source: Chesapeake Energy Corporation 2007-11 Form 10-K’s
With the exception of a large loss in 2009 due to impairment (where an asset is found to
be worth less than its book value and the loss has to be carried on the year’s income
statement), Chesapeake has exhibited reliable profitability over the past five years.
11
Revenue peaked in 2008 due to high natural gas and oil prices, but has increased over
the past two years.
Chesapeake’s three main revenue streams come from the production, processing
services, and oilfield services. The production operating segment is responsible for both
exploring and extracting natural gas and oil deposits. The processing segment is
responsible for marketing, gathering and compression of natural gas and oil primarily
from Chesapeake-operated wells. The oilfield services operating segment is responsible
for contract drilling, oilfield trucking, oilfield rental, pressure pumping and other
oilfield services operations for both Chesapeake-operated wells and wells operated by
third parties. Each of these segments operates profitably, but sales of oil and natural gas
account for over half of revenue and over 90% of operating income.
CONSOLIDATED STATEMENTS OF OPERATIONS (USD $) IN MILLIONS
12 Months Ending: Dec. 31,
2011
Dec. 31,
2010
Dec. 31,
2009
Dec. 31,
2008
Dec. 31,
2007
REVENUES:
Natural gas and oil $6,024 $5,647 $5,049 $7,858 $5,624
Marketing, gathering and
compression 5,090 3,479 2,463 3,598 2,040
Oilfield services 521 240 190 173 136
Total Revenues 11,635 9,366 7,702 11,629 7,800
OPERATING EXPENSES:
Natural gas and oil production 1,073 893 876 889 640
Production taxes 192 157 107 284 216
Marketing, gathering and
compression 4,967 3,352 2,316 3,505 1,969
Oilfield services 402 208 182 143 94
General and administrative 548 453 349 377 243
Natural gas and oil depreciation,
depletion and amortization 1,632 1,394 1,371 1,970 1,835
Depreciation and amortization of
other assets 291 220 244 174 153
(Gains) losses on sales and
impairments of fixed assets -391 -116 168 0 0
Impairment of natural gas and oil
properties 0 0 11,000 2,830 0
12
Restructuring 0 0 34 0 0
Total Operating Expenses 8,714 6,561 16,647 10,172 5,150
INCOME (LOSS) FROM
OPERATIONS 2,921 2,805 -8,945 1,457 2,650
OTHER INCOME (EXPENSE):
Interest expense -44 -19 -113 -271 -401
Earnings (losses) on investments 156 227 -39 0 83
Losses on purchases or exchanges of
debt -176 -129 -40 -4 0
Impairment of investments -16 -162 -180 0
Other income 23 16 11 -11 15
Total Other Income (Expense) -41 79 -343 -466 -303
INCOME (LOSS) BEFORE INCOME
TAXES 2,880 2,884 -9,288 991 2,347
INCOME TAX EXPENSE
(BENEFIT):
Current income taxes 13 4 423 29
Deferred income taxes 1,110 1,110 -3,487 -36 863
Total Income Tax Expense (Benefit) 1,123 1,110 -3,483 387 892
NET INCOME (LOSS) 1,757 1,774 -5,805 604 1,455
Net (income) attributable to
noncontrolling interests -15 -25 0 0
NET INCOME (LOSS)
ATTRIBUTABLE TO CHESAPEAKE 1,742 1,774 -5,830 604 1,455
Preferred stock dividends -172 -111 -23 -33 -94
NET INCOME (LOSS) AVAILABLE
TO COMMON STOCKHOLDERS 1,570 1,663 -5,853 504 1,233
Source: Chesapeake Energy Corporation 2007-11 Form 10-K’s
Chesapeake’s operations have generated roughly $5 billion in cash each of the previous
five years. This method of accounting eliminates the influence of impairment and
illustrates the large cash flows Chesapeake generates annually. Overall cash flows from
operations have increased at a modest 3.5% over the period shown below because while
production has expanded, natural gas and oil prices have fallen (see next paragraph for
more detail).
Chesapeake’s two major investing cash expenses include well drilling and
completion costs ($7.47B in 2011), and property and corporate acquisitions costs ($5.31B
13
in 2011); these are offset to some degree by proceeds from divestitures of property
($7.65B in 2011).
The net impact of financing on cash flow was relatively small in the past year but
there were large amounts associated on both proceeds from credit facilities borrowing
($15.5B in 2011) and payments to credit facilities borrowing ($17.4B in 2011).
CONSOLIDATED STATEMENTS OF CASH FLOWS (USD $) IN MILLIONS
12 Months Ended Dec. 31,
2011
Dec. 31,
2010
Dec. 31,
2009
Dec. 31,
2008
Dec. 31,
2007
CASH FLOWS FROM
OPERATING ACTIVITIES:
NET INCOME (LOSS) $1,757 $1,774 -$5,805 $604 $1,455
ADJUSTMENTS TO RECONCILE
NET INCOME TO CASH
PROVIDED BY OPERATING
ACTIVITIES:
Depreciation, depletion and
amortization 1,923 1,614 1,615 2,144 1,988
Deferred income tax expense
(benefit) 1,110 1,110 -3,487 -36 863
Unrealized (gains) losses on
derivatives 796 592 497 -712 415
Stock-based compensation 153 147 140 132 84
Accretion of discount on contingent
convertible notes 78 79 79 37
(Gains) losses or impairments on
sales of other property and
equipment -391 -116 168 0 0
(Gains) losses on investments -41 -107 39 38 0
Losses on purchases or exchanges of
debt 5 29 40 4 0
Impairment of natural gas and oil
properties 0 0 11,000 2,830 0
Impairment of investments 0 16 162 180 0
Other -3 32 39 -2 8
(Increase) decrease in accounts
receivable and other assets -530 -769 -31 -22 -257
14
Increase (decrease) in accounts
payable, accrued liabilities and other 1,124 717 -100 76 430
Cash provided by operating
activities 5,903 5,117 4,356 5,357 4,974
CASH FLOWS FROM INVESTING
ACTIVITIES:
Drilling and completion costs on
proved and unproved properties -7,467 -5,242 -3,572 -6,104 -5,305
Acquisitions of natural gas and oil
companies, proved and unproved
properties, net of cash acquired -5,313 -6,945 -2,268 -8,593 -3,003
Proceeds from divestitures of proved
and unproved properties 7,651 4,292 1,926 7,670 1,089
Additions to other property and
equipment -2,009 -1,326 -1,683 -3,073 -1,439
Proceeds from sales of other assets 1,312 883 176 41 36
Proceeds from (additions to)
investments 101 -134 -40 -74 -8
Cash used in investing activities -5,812 -8,503 -5,462 -9,965 -7,964
CASH FLOWS FROM
FINANCING ACTIVITIES:
Proceeds from credit facilities
borrowings 15,509 15,117 7,761 13,291 7,932
Payments on credit facilities
borrowings -17,466 -13,303 -9,758 -11,307 -6,160
Proceeds from issuance of senior
notes, net of offering costs 1,614 1,967 1,346 2,136 1,607
Proceeds from issuance of preferred
stock, net of offering costs 0 2,562 0 2,598 0
Cash paid to purchase debt -2,015 -3,434 0 -312 0
Cash paid for common stock
dividends -207 -189 -181 -148 -115
Cash paid for preferred stock
dividends -172 -92 -23 -35 -95
Cash received on financing
derivatives 1,043 621 109 -167 -91
Proceeds from sale of noncontrolling
interest 1,348 0 588 0 0
Proceeds from other financings 300 0 199 0 0
15
Distributions to noncontrolling
interests -9 0 -10 0 0
Net increase (decrease) in
outstanding payments in excess of
cash balance 353 20 -249 330 -98
Other -140 -88 -118 25 8
Cash provided by (used in)
financing activities 158 3,181 -336 6,356 2,988
Net increase (decrease) in cash and
cash equivalents 249 -205 -1,442 1,748 -2
Cash and cash equivalents,
beginning of period 102 307 1,749 1 3
Cash and cash equivalents, end of
period 351 102 307 1,749 1
Source: Chesapeake Energy Corporation 2007-11 Form 10-K’s
Chesapeake’s total production has expanded extremely rapidly over the past five years,
from 578.4 bcfe to 1,194 bcfe; this constitutes a 15.6% CAGR. Natural gas currently
accounts for 84% of Chesapeake’s production on an energy equivalence basis. This is a
notable decrease from the recent production composition, which tended to be in the
range of 92% natural gas, and represents a reaction to falling natural gas prices over the
past few years.
Indeed, the average sales price Chesapeake has received for natural gas fell from a
high of $7.74 per thousand cubic feet (mcf) in 2008 to only $3.12 per mcf in 2011,
without the use of derivatives. While natural gas accounts for 84% of production, it is
less than 70% of total sales value after hedging is accounted for.
On a per unit of production basis, Chesapeake’s largest expenses have been those
directly related to production, and those associated with the depreciation of the value of
natural gas and oil reserves. Interest expenses expressed in the following data are
misleadingly low as they are net of capitalized interest. Total interest expenses in 2011,
when not net of capitalized interest, are $776 million, or equivalent to $.65 per mcfe.30
Since 2006, Chesapeake has also aggressively expanded both the amount of proven
reserves it holds (16.0% CAGR) and the amount of reserves that are developed (10.9%).
It now holds reserves equal to more than 15 times current production levels.
16
PRODUCTION DATA
Net Production: 2011 2010 2009 2008 2007 2006
Natural gas (bcf) 1,004.1 924.9 834.8 775.4 655.0 526.5
Oil (mmbbl) 31.7 18.4 11.8 11.2 9.9 8.7
Natural gas equivalent (bcfe) 1,194.2 1,035.2 905.5 842.7 714.3 578.4
Natural Gas and Oil Sales ($ in
millions):
Natural gas sales $3,133 $3,169 $2,635 $6,003 $4,117 $3,343
Natural gas derivatives – realized
gains (losses) $1,656 $1,982 $2,313 $267 $1,214 $1,269
Natural gas derivatives – unrealized
gains (losses) -$669 $425 -$492 $521 -$139 $467
Total natural gas sales $4,120 $5,576 $4,456 $6,791 $5,192 $5,079
Oil sales $2,126 $1,079 $656 $1,066 $678 $527
Oil derivatives – realized gains
(losses) -$102 $74 $33 -$275 -$11 -$15
Oil derivatives – unrealized gains
(losses) -$120 -$1,082 -$96 $276 -$235 $28
Total oil sales $1,904 $71 $593 $1,067 $432 $540
Total natural gas and oil sales $6,024 $5,647 $5,049 $7,858 $5,624 $5,619
Average Sales Price (excluding
gains (losses) on derivatives):
Natural gas ($ per mcf) $3.12 $3.43 $3.16 $7.74 $6.29 $6.35
Oil ($ per bbl) $67.11 $58.67 $55.60 $95.04 $68.64 $60.86
Natural gas equivalent ($ per mcfe) $4.40 $4.10 $3.63 $8.39 $6.71 $6.69
Average Sales Price (excluding
unrealized gains (losses) on
derivatives):
Natural gas ($ per mcf) $4.77 $5.57 $5.93 $8.09 $8.14 $8.76
Oil ($ per bbl) $63.90 $62.71 $58.38 $70.48 $67.50 $59.14
Natural gas equivalent ($ per mcfe) $5.70 $6.09 $6.22 $8.38 $8.40 $8.86
Other Operating Income(c) ($ in
millions):
Marketing, gathering and
compression net margin $123 $127 $147 $93 $71 $55
17
Oilfield services net margin $119 $32 $8 $30 $42 $62
Other Operating Income(c) ($ per
mcfe):
Marketing, gathering and
compression net margin $0.10 $0.12 $0.16 $0.11 $0.10 $0.09
Oilfield services net margin $0.10 $0.03 $0.01 $0.04 $0.06 $0.11
Expenses ($ per mcfe):
Production expenses $0.90 $0.86 $0.97 $1.05 $0.90 $0.85
Production taxes $0.16 $0.15 $0.12 $0.34 $0.30 $0.31
General and administrative
expenses $0.46 $0.44 $0.38 $0.45 $0.34 $0.24
Natural gas and oil depreciation,
depletion and amortization $1.37 $1.35 $1.51 $2.34 $2.57 $2.35
Depreciation and amortization of
other assets $0.24 $0.21 $0.27 $0.21 $0.22 $0.18
Interest expense $0.03 $0.08 $0.22 $0.27 $0.51 $0.52
Interest Expense ($ in millions):
Interest expense $30 $99 $227 $235 $365 $301
Interest rate derivatives – realized
(gains) losses $7 -$14 -$23 -$6 $1 $2
Interest rate derivatives –
unrealized -gains) losses $7 -$66 -$91 $85 $40 -$2
Total interest expense $44 $19 $113 $314 $406 $301
Wells
Net Wells Drilled 1,282 1,149 1,003 1,733 1,919 1,449
Net Producing Wells as of the End
of Period . 22,617 22,919 22,813 21,404 19,079
Proved Reserves
Natural Gas (bcf) 15,515 15,455 13,510 11,327 10,137 8,319
Oil (mmbbl) 545.5 273.4 124.0 120.6 123.6 106.0
Total (bcfe) 18,789 17,096 14,254 12,051 10,879 8,956
Proved developed reserves
Natural Gas (bcf) 8,578 8,246 7,859 7,582 6,409 5,113
Oil (mmbbl) 254.6 149.3 78.8 84.9 88.8 76.7
18
Total (bcfe) 10,106 17,096 8,331 8,091 6,941 5,573
Source: Chesapeake Energy Corporation 2007-11 Form 10-K’s
INDUSTRY COMPARISON
The table below compares key statistics among the seven largest domestic producers of
natural gas. Chesapeake is dwarfed in size by the multinational integrated petroleum
firms that it competes with, but it is one of the largest dedicated extractors. Anadarko
Petroleum and Devon Energy are most similar to Chesapeake in size. While
Chesapeake has more employees than these companies due to its high level of vertical
integration, it has a smaller market capitalization because more of its capital takes the
form of debt.
In terms of profitability measures, it is difficult to make a perfect comparison
between Chesapeake and the multinational petroleum companies whose operations are
more focused on oil and are integrated along the entire supply chain. However,
Chesapeake compares favorably to both its closest competitors and the industry in
general. Its gross profit margin is highest among this group, indicating that Chesapeake
operates very efficiently. Net profit margin, return on equity, and return on assets are
all higher than industry average.
Chesapeake trades at a discount relative to the industry and most of its key
competitors. This is likely a reflection of two things: First; that investors are wary of
Chesapeake’s debt-heavy and illiquid financial position. Indeed, Chesapeake is much
more levered and less liquid than its competitors. Second, Chesapeake places a larger
emphasis on natural gas extraction over oil extraction than many of its competitors, and
investors are reacting to the recent fall in natural gas prices.
FINANCIAL INDICATORS: SEVEN LARGEST DOMESTIC NATURAL GAS PRODUCERS
XOM CHK APO DVN BP ECA COP Industry
Key Statistics
Annual NG
Production
(bcf) 1,424
1,004
876 730 694 657
584 28,576
19
Natural Gas as
% of Total
Production 49 84 68 81 -- 95 48
Annual Sales
(Billion US$) $486.4 $11.6 $14.0 $11.5 $386.5 $8.5 $251.2
Employees 82,100 12,600 4,800 5,200 83,400 4,276 29,800
Market Cap
(Billion US$) $401.3 $14.7 $38.0 $25.0 $135.2 $13.6 $93.7
Profitability
Gross Profit
Margin 36.9% 87.3% 58.4% 68.9% 19.9% 65.9% 21.7% 69.3%
Net Profit
Margin 8.4% 13.5% -19.0% 41.1% 6.7% 1.5% 5.0% 12.2%
Return on
Equity 27.3% 12.2% -13.7% 23.1% 24.9% 0.8% 18.6% 7.5%
Return on
Assets 13.0% 4.0% -5.1% 12.7% 9.1% 0.4% 8.0% 3.7%
Valuation
Price/Sales
Ratio 0.87 1.5 2.79 2.6 0.37 1.71 0.42 4.35
Price/Earnings
Ratio 10.3 9.99 -14.73 13.95 5.58 114.94 8.47 27.32
Price/Book
Ratio 2.65 1.13 2.16 1.34 1.28 0.89 1.49 2.58
Price/Cash
Flow Ratio 7.64 2.95 15.58 4.78 6.48 3.59 5.37 9.07
Financial
Current Ratio 0.94 0.45 1.41 1.38 1.16 1.75 1.08 1.2
Quick Ratio 0.66 0.41 1.22 1.25 0.69 0.82 0.82 0.87
Leverage Ratio 2.14 3.08 2.86 1.92 2.63 2.08 2.35 2.02
Total
Debt/Equity 0.25 0.78 0.84 0.46 0.4 0.5 0.35 0.44
Source: Hoover’s
STOCK PRICE AND ANALYST OPINIONS
Chesapeake’s stock price reached a recent peak of over $65 in June 2008, but dropped
over 75% by February 2009 as a result of falling natural gas prices and the recession.
Earnings expectations are very dependent on natural gas prices, and as such natural gas
prices have a large influence on Chesapeake’s stock price. The current consensus
20
analyst opinion on Chesapeake is a weak buy. Average revenue estimates forecast 13%
growth each year for the next two years.4
PRICE: CHESAPEAKE VS. S&P 500
Source: Yahoo Finance
U.S. NATURAL GAS WELLHEAD PRICE (DOLLARS PER THOUSAND CUBIC FEET)
Source: Energy Information Administration
0
200
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0
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CHK
S&P 500
$0.00
$2.00
$4.00
$6.00
$8.00
$10.00
$12.00
Jan
-20
03
Jul-
20
03
Jan
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04
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04
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20
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COMPETITIVE ANALYSIS
The main source of competitive pressure in the natural gas extraction industry is
internal rivalry; there is a high level of existing competition due to the numerous large,
established companies involved and the commodity-based nature of the product. High
capital costs and the need for specialized technology ensure that the threat of entry is
very low. Neither the suppliers nor the buyers of this industry wield significant power
over its participants. The substitutability of the product is low in the short run but
becomes much higher over time. In the current environment of low natural prices, this
means that competition is increased in the short term but will decrease if prices return
to previous levels.
INTERNAL RIVALRY
Chesapeake faces competition from both independent firms focused on natural gas
extraction and large multinational petroleum companies. Independent natural gas
extractors range from large firms such as Devon Energy and Anadarko Petroleum that
are similar in size to Chesapeake and operate on a national scale to smaller players such
as Delta Petroleum that only operate one field. At the other end of the scale, Exxon
Mobil is the nation’s largest extractor of natural gas, producing 3.9 bcf of dry natural
gas a day to Chesapeake’s 2.6 bcf.5 BP, ConocoPhillips, and Chevron are also major
producers. There are few economies of scale in this industry, and thus Chesapeake faces
competition from firms both large and small. The market is fairly fragmented; the five
largest domestic producers of natural gas only account for 16.5% of total US
production.6,7 Extractors compete over contracts to sell their natural gas and liquids as
well as properties for exploration and development and the personnel needed to
perform the extraction.
Natural gas extractors suffer increased competition because there is no product
differentiation in the market. Contracts for natural gas delivery are settled largely on
price; because of this, firms are forced to manage costs intensely as a way of obtaining
competitive advantage. There are two main ways in which firms in the natural gas
industry commonly attempt to gain a cost advantage. First, they vertically integrate into
the midstream in order to deliver their product at a lower cost. Second, they attempt to
22
use advanced drilling techniques and equipment, such as horizontal drilling to access
unconventional sources. The recent fall in price of natural gas has only added to the
need for firms in this industry to manage cost.
ENTRY THREAT
The threat of entry in the natural gas extraction market is low primarily because of the
high capital costs involved and the need for specialized, often proprietary, equipment
and knowledge. The installation and operation of a gas well is a complex process,
especially as shale drilling, horizontal drilling and other techniques become more
popular; one report estimates that unconventional methods will account for more than
half of production by 2020.8 In a commodity-based, cost-driven industry such as this, a
new entrant also cannot afford to learn by doing so the only credible threat of entrance
comes from those who already have industry experience.
Other factors also add to the difficulty of entering this market. Natural gas extraction
is location dependent and as such new entrants on any significant scale must compete
with existing players, who have already developed reputations and relationships, for
land leasing rights. On the other end of the value chain, most natural gas extractors rely
on an existing set of distribution pipeline, and unless an entrant is able to construct their
own system they also have to compete on that end as well. The complex environmental
regulations surrounding the industry add to the difficulty as well. Perhaps the sole
advantage entrants have in the natural gas industry is the lack of significant economies
of scale.
BUYER POWER
The commodity nature and structure of the natural gas market ensures that neither
extractors nor their buyers tend to have significant power over one another. Depending
on their level of vertical integration, natural gas extractors sell to marketers,
distributors, or directly to the end user. In any case, the lack of product differentiation
and multitude of different channels to purchase natural gas guarantee that most
extractors have many buyers to choose from. At the same time, the lack of product
differentiation ensures that most buyers also have a large number of different options in
23
the market. Transportation prices tend to determine sales patterns, and only for very
small or remote extractors is buyer power significant.
SUPPLIER POWER
Natural gas extraction requires two main inputs: Land rich in gas deposits and oilfield
service teams. Supplier power is low for all of these inputs in most circumstances.
In the case of land, suppliers are those holding real estate in areas thought to be rich
in natural gas. They do not wield considerable power because of the imprecision
typically involved in estimating the value of land thought to contain natural gas. The
quantities and ease of extracting gas deposits are not well known until after a thorough
geological study, and cannot be determined exactly until a well is drilled. Extractors
typically establish leasehold over land before these tasks are performed. Because of this
uncertainty and the impairment loss associated with drilling an empty well, extractors
are typically unwilling to commit many resources to single investments. Even in
situations where the size of natural gas deposits is well known, the commodity nature
of the product means that the value of the land is fairly fixed and cannot be raised high
than is economical for the extractors. Moreover, the geologic formations that tend to
contain natural gas are broad in extent.
Oilfield service companies provide a range of services on a drill site, ranging from
drilling rig operation to compression to transportation. Supplier power from oilfield
services companies can be substantial because of the specialized nature of modern
unconventional drilling techniques. However, no major suppliers dominate the market,
and vertical integration between extraction companies like Chesapeake and oilfield
service teams is common, preventing suppliers of these services from exploiting their
key role in the production process.
SUBSTITUTES
The substitutability of natural gas is low in the short term but in the medium to long
term. Natural Gas’s primary uses are in industry (32%), electricity generation (24%),
and residential applications (22%).9 In all of these areas it is used as an energy and heat
source, and its primary substitutes are other carbon fuels like coal and oil. The low
short-term substitutability between gas and other carbon fuel sources comes from the
24
large capital investments required for their installation. This creates a large switching
cost associated with changing between different fuel sources. There are a limited
number of power plants that are able to switch between oil and natural gas as their fuel
source, but they only represent a small proportion of overall capacity.10
In the long term, natural gas can be adapted to a number of different usages,
including fueling smaller motor vehicles through compressed natural gas, or larger
long-haul vehicles such as trucks, planes, and ships through more compact liquefied
natural gas. These technologies are not currently widespread because historical natural
gas prices have not been low enough to make them economical, but in the current era of
low prices they are undergoing rapid development starting with fleet vehicles which
can refuel every day at a central location and short haul truck operations that originate
and deliver to consistent locations.
COMPLEMENTS
Natural gas use is especially concentrated in the pulp and paper, metal, chemical,
petroleum, plastic, and food processing industries, which together account for over 84
percent of all industrial natural gas usage.11 As such, the products produced by these
industries are complements to natural gas use. Because a major use of natural gas is in
residential heating, usage is also highly positively correlated to the severity of winter.
Finally, as the aforementioned emerging natural gas technologies become more
prevalent, those new products will serve as complements as well.
SWOT ANALYSIS
STRENGTHS
Expertise in unconventional drilling methods. Chesapeake’s business strategy
emphasizes using drilling techniques such as hydraulic fracturing and
horizontal drilling to allow them to access deposits that would not otherwise
be economical. This allows Chesapeake to differentiate themselves from other
25
drillers who are not focused on using these techniques, reducing the degree to
which they are competing over the same reserves.
Extensive land and drilling inventory. In recognition of the potential for new
drilling methods to access previously inaccessible deposits, Chesapeake has
aggressively purchased leaseholds in major oil and natural gas plays for the
past six years. Their current level of proven reserves is enough to provide for
nearly twenty years of drilling at this year’s rate of roughly 1.2 tcfe.
Proprietary technology. Chesapeake has developed three major pieces of
technology that complement its drilling programs. The first of these is a large
inventory of 3D seismic data which identifies deposits that were previously
undiscovered and allows for more accurate placement of wells. Second is an
information system that gives management the ability to monitor new plays
and competitors’ activity. Lastly, Chesapeake has developed a geologic center
in Oklahoma City that analyzes cores from newly drilled wells to better
evaluate the productivity of newly drilled wells and the likelihood of other
nearby productive deposits.
WEAKNESSES
Debt level. Chesapeake’s high level of debt is disadvantageous in a number of
ways. Financing the existing debt may be difficult if cash flows are not steady.
This is particularly relevant in the current environment of depressed natural
gas prices. Furthermore, high levels of debt will make it more expensive for
the company to finance additional acquisitions. While Chesapeake already has
a large leasehold inventory, land acquisition is critically important to an
extraction company, and the inability to do this may impede future growth.
Environmental and Safety Liabilities. The production and transport of natural
gas and petroleum products is inherently dangerous and Chesapeake is
vulnerable to legal action in the event of an accident. In May 2011, a pipeline
blowout in Bradford County, Pennsylvania cost Chesapeake more than
$500,000 dollars in punitive fees from the Pennsylvania Department of
Environmental Protection.12 While these fees are largely significant given the
26
scale of Cheapeake’s operations, they illustrate the general level of
vulnerability to these kinds of accidents.
Large capital requirements. The process of acquiring, exploring, developing,
and processing natural gas and oil is very capital intensive, and if Chesapeake
cannot fund these expenditures, they will be forced to reduce the scale of their
operations. This is a problem because even though Chesapeake holds leases
over a large amount of real estate, many of these leases are structured such
that if the company does not begin drilling operations within three to five
years of the contract’s inception, it will lose leasehold over the land.
OPPORTUNITIES
Joint ventures. Chesapeake has already entered into several joint ventures
with multinational petroleum companies wherein the company sells a share of
its interest in a leasehold in exchange for cash. In all of these arrangements,
Chesapeake continues to operate the leasehold as normal and also gains
revenue for processing the partner’s share of the extracted natural gas and oil.
These arrangements allow Chesapeake to recover some of the capital costs
associated with production, effectively monetizing existing assets
immediately.13
Technologies that increase US demand for gas. Natural gas can serve in many
of the roles that oil currently does. However, historical natural gas prices have
been too high to justify developing the infrastructure and technology
necessary to do this in all applications. The most significant opportunities are
in transportation, and there are several initiatives, such as the Pickens Plan, to
develop national infrastructure for natural gas vehicles. These technologies
would increase domestic demand for natural gas and thus increase prices.
Export gas to more profitable markets. Another technology that may provide
opportunities for Chesapeake is mass liquefied natural gas transport.
Container ships built expressly for this purpose carry gas compressed at 600
times its normal density, and allow economical transport of natural gas across
oceans, which was not previously possible. Liquefaction terminals are
27
currently being constructed throughout the United States, and once more of
these are operational, Chesapeake’s gas can be exported to other places where
prices are much higher. While gas trades at roughly $2.50 per million BTUs in
the United States, it costs as much as $9 per million BTUs in Europe and up to
$16 in Asia.14
THREATS
Price fluctuation / Value of reserves less than expected. Low gas prices directly
affect Chesapeake’s income from operations. In addition, much of
Chesapeake’s current value is tied to the estimated value of the deposits in the
land that it leases. If these decline in value, either because natural gas prices
fall or because the deposits are less productive than expected, Chesapeake
stands to lose a great deal of money. In 2009, Chesapeake had impairment
costs of $11 billion, which was greater than total revenue for the year.15
Chesapeake may also be harmed if unproved deposits, which have not yet
been accurately estimated, on the land it leases are less than estimated. There
is a great deal of uncertainty as to the value of unproved reserves; the
government’s Energy Information Administration recently halved its
estimates for the quantity of unproved reserves in the United States.16
Legislation. Chesapeake is vulnerable to legislation that would increase costs,
in particular environmental legislation. Even though natural gas is cleaner
than oil or coal in terms of carbon output per unit of energy produced, it is
still a source of greenhouse gases. Hydraulic fracturing, which Chesapeake
uses in virtually all of its wells to increase productivity, is also subject to
scrutiny on the basis of groundwater contamination and releasing pollutants.
As such, Chesapeake may faced increased costs, bureaucracy, or monitoring if
the government passes environmental laws
Development of other energy sources. Given natural gas’s substitutability
with other carbon fuel sources, expanded production of those energy sources
may drive down prices of those products and thus reduce demand for natural
gas. A notable example of this is the oil sand in central Canada. If the
Keystone XL pipeline is approved in 2013, the increase in the supply of oil to
28
the United States may adversely affect natural gas prices and thus
Chesapeake’s profitability. Even if the Keystone project is not approved, oil
could be piped to Canada’s west coast for export to Asia through the
proposed Enbridge Northern Gateway Project.
STRATEGIC RECOMMENDATIONS
SHIFT PRODUCTION TOWARDS OIL
Currently, 84% of Chesapeake’s production is natural gas on an energy equivalent
basis17. Over the past five years, oil has become increasingly attractive relative to natural
gas. While in 2006, the average sales price Chesapeake received for oil was 60% greater
than that of an equivalent amount of natural gas, in 2011 oil was priced at 241% more
than its natural gas equivalent.18
Chesapeake will benefit from shifting more production to oil in three main ways.
First, Chesapeake will simply be earning a higher return on the capital it invests in
exploring, drilling, and completing new wells. Production costs are not significantly
different between the two resources, so shifting to oil should not significantly increase
overall costs.31
Second, more production of oil increases the diversification of Chesapeake’s revenue
sources. Oil and natural gas prices are not perfected correlated, and thus by achieving a
more balanced mix, Chesapeake can in effect reduce the risk of future revenue without
the use of derivatives such as futures.
Finally, shifting production to oil is essential because efforts to increase domestic
natural gas demand will require substantial time to take effect and natural gas prices
may stay low for years.
IMPROVE THE BALANCE SHEET
Natural gas extraction is an extremely capital intensive industry; as such, it is natural
that Chesapeake has used substantial amounts of corporate debt to finance its
29
expansion. However, carrying excessive debt has many drawbacks. Chesapeake’s
current debt rating from Moody’s is Ba3, indicating that it is below investment grade.
Higher levels of debt cause reduced credit ratings, making capital more expensive.
When income is highly variable and interest payments are large, there is also a
substantial risk of default. The threat of default also exerts downward pressure on stock
price, harming shareholders.
Chesapeake should continue to reduce debt by divesting its existing assets. These
assets may either be undeveloped leaseholds or operational wells. In either case, selling
these assets will reduce Chesapeake’s reserves, and possibly future production.
Fortunately, Chesapeake has proved reserves equal to more than fifteen times current
production levels. The benefit of a lowered financing cost structure is well worth it, as
cost control is essential for success in a commodity based market.
Chesapeake should also seek to negotiate additional joint ventures in order to reduce
the capital requirements of its operations. Partners in these joint ventures can take many
forms. Most of Chesapeake’s partners at year end 2011 were foreign multinational
petroleum companies such as Total S.A. or the China National Offshore Oil
Corporation.20 However, in March 2012, Chesapeake also made a $250 million deal with
private equity firm Kohlberg, Kravis, and Roberts.21 By selling a stake in production of a
well in exchange for cash, it can rely less on debt in its operational structure.
INVEST IN NATURAL GAS TECHNOLOGIES
Historically, natural gas prices have been high enough to discourage the development
of natural gas equivalents of common oil technology. However, with prices at their
current levels, natural gas has become a much more attractive alternative. This is
especially true in transportation, where natural gas can serve as a replacement for
gasoline and diesel. In 2011, nationwide average prices for gasoline and diesel were
$3.69 and $4.04 per gallon respectively. An equivalent amount of natural gas cost only
$2.03.22 By encouraging the development of technologies that use natural gas,
Chesapeake will increase future demand.
Chesapeake has already made several investments to promote natural gas usage.
Through its subsidiary NG Ventures, it has spent $160 million to partner with Clean
30
Energy Fuels Corporation to build national natural gas refueling infrastructure, and
another $150 on hybrid natural gas / bio-fuel technology.23 Chesapeake must further
increase spending on infrastructure development, as the current plans will provide less
than a third of what is required to build an effective national infrastructure.24 It should
also invest in technologies that allow the conversion of the nation’s existing diesel fleet
to natural gas, minimizing the switching costs vehicle owners are forced to pay.
LOBBY CONGRESS TO IMPLEMENT PRO-NATURAL GAS REGULATIONS
As mentioned earlier, legislation unfriendly to natural gas is one of the greatest threats
Chesapeake faces. At the same time, natural gas can be an attractive fuel source
politically for several reasons, and Chesapeake must take advantage of this by using the
government to help promote natural gas over its substitutes.
First, of course, is natural gas’s relatively low cost to consumers. In regions where
cities are structured with the automobile as the primary method of transportation,
particularly in the west, high gasoline prices bear a heavy cost on the general
population. By legislating subsidies for natural gas usage, elected officials can reduce
the burden of transportation costs on their constituents.
A second political argument for natural gas concerns energy independence. In 1970,
the United States imported less than quarter of its oil. In 2011, it imported almost 60%.25
Much of this oil comes from potentially unstable and hostile OPEC nations, and as a
result energy concerns play a major role in foreign policy. Several movements, such as
the Pickens Plan, have identified natural gas as a potential replacement for foreign oil
imports. By partnering with these organizations and reach out to members of congress
that are concerned with energy security, Chesapeake can further its support in the
government.
The environmental movement is a final political consideration that works in favor of
natural gas. Among carbon fuel sources, natural gas has the lowest output of green
house gases; it creates 117 pounds of carbon dioxide per million btu of energy input,
versus oil’s 164 and coal’s 208.26 This is particularly relevant because the two sectors
that are responsible for the most greenhouse gas output are transportation and
electricity generation; transportation is almost completely reliant on oil, and coal is the
31
largest source of domestic power generation.27 Thus, natural gas can also satisfy those
politicians with an environmental agenda.
ENCOURAGE THE DEVELOPMENT OF EXPORT CAPABILITIES
Liquefied natural gas transport technology allows natural gas to be compressed to
1/600th of its normal volume and transported across oceans where pipelines are
uneconomical. The Western Hemisphere has developed LNG import infrastructure, but
is lacking in export terminals. In all of North and South America, there are currently
only three operational LNG export terminals, in Peru, Trinidad, and Alaska.28 The
expansion of shale gas drilling activity, economic growth in Asia, and incidents like the
Fukushima meltdown have shifted prices so that it is now much more economical to
export natural gas to the East, and LNG export facilities are currently being built, with
most projected to come online some time from 2015 to 2017.29
The size and speed with which LNG exports increase will have an enormous
influence on the domestic price of natural gas. The Energy Information Administration
recently conducted a study on this matter, using different assumptions about the rate
and scale of adoption. In the high estimate that assumes that about 18% of current
production levels will be exported annually, long term natural gas prices range from
thirty to twenty percent higher than in the reference case with no exports. In the low
estimate, where half that amount is exported, exports result in ten percent higher
natural gas prices. The speed with which these effects take places also greatly varies,
from roughly 2016 in the rapid cases to 2025 or later in the slow scenarios.32
Given the wide range of possible outcomes, and the large effect they could have
on domestic gas prices, Chesapeake needs to use its size and influence in the extraction
segment of the natural gas industry to increase the scale of and accelerate the
construction of these terminals in whatever way it can. In particular, Chesapeake must
protect the development of LNG liquefaction terminals from legislation that seeks to
maintain low natural gas prices in the United States.
.
32
ENDNOTES
1Chesapeake Energy Corporation 2011 Form 10-K
2http://www.chk.com/About/Pages/History.aspx
3Chesapeake Energy Corporation 2011 Form 10-K
4http://finance.yahoo.com/q/ao?s=CHK+Analyst+Opinion
5http://marcellusdrilling.com/2011/09/the-10-largest-natural-gas-drillers-in-the-u-s/
6http://marcellusdrilling.com/2011/09/the-10-largest-natural-gas-drillers-in-the-u-s/
7http://www.eia.gov/dnav/ng/hist/n9190us3m.htm
8http://www.pennenergy.com/index/articles/display/359003/articles/oil-gas-
journal/drilling-production/ziff-us-unconventional-gas-share-to-leap.html
9http://www.naturalgas.org/overview/uses.asp
10http://seekingalpha.com/article/162361-fuel-substitution-power-plants-currently-
switching-to-natural-gas
11http://www.naturalgas.org/overview/uses_industry.asp
12http://www.essentialpublicradio.org/story/2012-02-10/bradford-county-blow-out-
costs-chesapeake-more-250k-10157
13Chesapeake Energy Corporation 2011 Form 10-K
14http://seekingalpha.com/article/448401-exporting-natural-gas-would-be-very-
profitable-for-north-american-e-p-companies
15Chesapeake Energy Corporation 2009 Form 10-K
16AML Macro Limited 3-7-2012
17Chesapeake Energy Corporation 2011 Form 10-K
18Chesapeake Energy Corporation 2011 Form 10-K
33
19http://www.moodys.com/credit-ratings/Chesapeake-Energy-Corporation-credit-
rating-600013391#
20Chesapeake Energy Corporation 2011 Form 10-K
21http://seekingalpha.com/article/442481-chesapeake-energy-is-making-a-lot-of-the-
right-moves
22http://www.ngvc.org/about_ngv/index.html
23http://www.chk.com/Affiliates/Chesapeake-NG-Ventures/Investment-
Portfolio/Pages/information.aspx
24http://seekingalpha.com/article/442481-chesapeake-energy-is-making-a-lot-of-the-
right-moves
25http://www.pickensplan.com/theplan/
26http://www.naturalgas.org/environment/naturalgas.asp
27http://www.eia.gov/electricity/monthly/pdf/execsum.pdf
28http://seekingalpha.com/article/472141-investing-in-the-lng-market
29http://seekingalpha.com/article/472141-investing-in-the-lng-market
30Chesapeake Energy Corporation 2011 Form 10-K
31http://www.eia.gov/pub/oil_gas/natural_gas/data_publications/cost_indices_equipme
nt_production/current/coststudy.html
32http://205.254.135.7/analysis/requests/fe/