Chesapeake Energy Corp. has made a new natural gas discovery in the Haynesville Shale in Louisiana. In addition, the company announced two other new unconventional natural gas discoveries and five new unconventional oil projects. Because of these discoveries, the company has decided to increase its capital expenditure budget for 2008 and 2009 to increase drilling and leasing activity on these new plays as well as its three most important existing unconventional shale plays: the Barnett Shale, the Fayetteville Shale, and the Marcellus and Lower Huron Shales in Appalachia.
New unconventional gas discoveries
Based on the past two years’ research and the results of three horizontal and four vertical wells drilled, Chesapeake believes the Haynesville Shale play could have a larger impact than any other play in which it has participated. The company plans to increase drilling in the play from four rigs to 10 by the end of the year and potentially more in 2009.
The company currently owns or has commitments for more than 200,000 net acres in the area with acquisition efforts underway with the goal of owning up to 500,000 net acres.
Colony Granite Wash
Chesapeake is also working the discovery of the Colony Granite Wash play in Washita and Custer Counties, Okla. Developed internally two years ago, the Colony Granite Wash play is now producing 40 million cubic feet of natural gas equivalent per day (MMcfe/d) net to the company from 12 net horizontal wells. Chesapeake is utilizing four rigs to further develop the 60,000 net acre leasehold in the Colony Granite Wash play. It anticipates the drilling of approximately 250 additional net horizontal wells over time.
Mountain Front Granite Wash
During the past few months, Chesapeake has drilled three horizontal Granite Wash wells along the 150 mile Mountain Front area of the Anadarko basin. The company expects the current leasehold of nearly 75,000 net acres will accommodate the drilling of roughly 400 additional net horizontal wells over time.
New unconventional oil projects
Chesapeake has also identified five new unconventional oil projects, four of which have been developed on a proprietary basis. The projects range in size from 100,000 to 1,000,000 acres. The company has started oil production in two of the projects and initial drilling in the other projects is scheduled during the next 12 months.
In addition to the increased drilling and leasing activity on the new discoveries and projects, Chesapeake plans to increase drilling and leasing activities in several of its existing shale plays.
Fort Worth Barnett Shale
Chesapeake is continuing its drilling and leasing program in the Barnett Shale, particularly in the Core and Tier 1 area of Tarrant, Johnson, and western Dallas counties. The company’s net natural gas production in the Barnett Shale is now approximately 450 MMcfe/d. By year-end, the company expects to increase the rig count in this area from 40 to 45 rigs.
In the Fayetteville Shale, Chesapeake’s net natural gas production is now approximately 130 MMcfe/d. The company plans to increase its Fayetteville Shale drilling activity from 12 rigs to roughly 25 rigs by early 2009 in response to the recent 10% increase in expected estimated ultimate per well recoveries for these wells.
Marcellus and Lower Huron Shales
Chesapeake owns a leasehold position of 1.6 million net acres in the Marcellus and Lower Huron Shale plays. The company has drilled 26 vertical and horizontal Marcellus and Lower Huron shale wells and plans to drill roughly 165 vertical and horizontal shale wells in 2008 and 2009.
Increased drilling activity, production forecasts, gas hedging positions
In light of higher per well reserve recovery expectations and decreasing per well costs in key shale plays, the company plans to increase its drilling activity levels. Specifically, Chesapeake plans to increase its current drilling activity levels in the Fort Worth Barnett Shale, Fayetteville Shale, and Haynesville Shale plays by 24 operated rigs by year-end 2008.
As a result of the new discoveries and projects, the company plans to spend an additional $275 million and $675 million for drilling and leasehold in 2008 and 2009, respectively, as compared to its previous spending plans.
Due to higher recovery expectations and increased drilling activity levels, the company has raised its 2008 and 2009 production forecasts by 30 and 100 MMcfe/d, respectively. Accordingly, Chesapeake now expects its average daily production rate to increase in 2008 by approximately 21% over its 2007 average rate to 2,370 MMcfe/d and in 2009 by approximately 16% to 2,740 MMcfe/d. These are increases of 5% and 33%, respectively, over 2008 and 2009 production growth levels of 20% and 12% previously projected by the company.
“We believe we must invest the necessary capital to more fully capture the upside of our new opportunities. We remain focused on per-share value creation and we believe our shareholders will benefit from our increased investments in these new discoveries and projects and in our most important existing plays.” – Aubrey K. McClendon, CEO, Chesapeake Energy Corp.
In response to the strength of natural gas prices experienced during early March, the company added to its 2008 and 2009 natural gas hedging position and began to hedge a portion of its expected production in 2010.
Chesapeake currently has hedged, using swaps, approximately 71%, 40%, and 12% of its expected 2008, 2009, and 2010 natural gas production at average NYMEX prices of $8.77, $9.13, and $9.34 per mcf, respectively. Additionally, the company has hedged, using collars, approximately 6% of its expected 2008 and 2009 natural gas production at an average NYMEX floor price of $7.88 per mcf and an average NYMEX ceiling price of $9.64 per mcf in 2008 and an average NYMEX floor price of $8.22 per mcf and an average NYMEX ceiling price of $10.70 per mcf in 2009.
The company has stated that it may either increase or decrease its hedging positions at any time in the future without notice.
Revised capital funding plans
Chesapeake believes the combination of developing the new discoveries and projects, increasing drilling activity levels to accelerate the development of existing plays, and the higher cost of acquiring leasehold in some of the company’s plays calls for an increase in the company’s capital expenditures.
The company had planned to fund its 2008 and 2009 capital expenditures through cash flow from operations, borrowings under its revolving credit facility, and from producing property monetizations and the sale of a minority interest in a private partnership for the company’s midstream assets. These initiatives remain on track for completion in the second quarter of 2008, although current uncertainty in the financial markets could impact this timing.
Considering that uncertainty and the increasing number of upside growth opportunities available, the company now expects to fund some or all of these additional expenditures through the public capital markets. While a departure from original plans, Chesapeake believes that the potential incremental financial returns available from its increased capital spending will exceed the expected capital costs.