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Chesapeake Energy (CHK)Stock (Energy Industry, Independent Oil & Gas Industry)
 Though much of the company's previous growth was financed through debt, Chesapeake has decided to sell assets that do not fit its long-term goals, a plan that will allow the company to spend on exploration and drilling without borrowing money. In the future, oil price fluctuations could greatly affect drilling margins, especially in more geologically difficult reserves; though Chesapeake has its fair share of unconventional, expensive reserves, a large amount of the company's gas is taken from wells that are relatively easy to extract from. Unseasonal gas prices potentially threaten Chesapeake's profitability, as lower gas prices during warmer winters depress margins if Chesapeake does not react and reduce potential revenues if the company cuts back production. Natural gas has been touted as the next big fuel, however, as it burns cleaner, more efficiently, and cheaper than oil, and is increasingly more abundant; a transition away from the black gold and towards natural gas would make Chesapeake very rich in comparison to more oil dependent competitors like Devon Energy. Chesapeake's other competitors include Anadarko Petroleum, EnCana, Apache, Comstock Resources, and Cabot Oil & Gas. [edit] Business and FinancialsChesapeake has grown significantly in the past few years, with about 50% revenue growth from 2005 to 2006, and operating income nearly doubling in the same period.
Source: CHK 2006 Annual Report[3]. The company has a three-pronged growth strategy:
Sources: CHK 3Q07 News Release[7] and CHK 2006 Annual Report[8].
[edit] Chesapeake Wants to Fund its Growth InternallyChesapeake's sale of the Kerr-McGee property in July 2007 highlights a major part of its new growth strategy. The company is selling off some of its properties and rigs; the resulting cash could help the company grow without increasing its debt. By the end of 2009, Chesapeake wants to sell about $4 billion worth of assets (for cash); it has commenced its plan, selling 37 rigs in the third quarter for $235 million[9] , as well as a volumetric production payment for some Appalachian holdings in early January to Deutsche Bank AG (DB) and UBS AG (UBS) affiliates for $1.1 billion[10]. [edit] Trends and Forces[edit] Chesapeake has Protected itself Against Oil Price FluctuationsOil and gas prices have fluctuated heavily over the past few years, though the most recent trend is a rise in prices, with a barrel of oil trading in international market a day after the new year at just over $100. While Chesapeake currently benefits from high prices, the profitability of the current market will drive increased exploration and production, which could eventually cause prices to fall and margins to drop. In this instance, many oil and gas companies that are taking advantage of higher prices by investing in expensive extraction technologies (like Devon Energy's deepwater plays) will be stung by falling margins, as costs stay high but revenues decrease. Chesapeake isn't missing out on the big money in the current market as it produces over 1000 Bcfe per day from unconventional, expensive-to-produce reserves[11], and is expanding these holdings, announcing in June 2008 a $178 million JV with Goodrich Petroleum to develop the Haynesville Shale[12]; in the event of a price level downturn, however, Chesapeake's production of 980 MMcfe per day out of conventional reserves, which are much cheaper to extract from than unconventional reserves, will protect it against margins declines. [edit] Chesapeake's Chips are on the Barnett ShaleWith the company's production in the resource at over 400 MMCfe net per day, the Texas Barnett Shale[13], is already one of Chesapeake's main unconventional production centers. Oil shales, like Barnett Shale, are more expensive to produce because the oil has been absorbed into sedimentary rock, and must be released through a complex heating process. In a high-price market, the Barnett Shale' growth has been phenomenal, as Chesapeake's June 2007 production in the region was only around 230 MMCfe[14]; production has nearly doubled, and with 20% of its capital to be concentrated in the area, the company expects growth to continue. [edit] Seasonal Natural Gas Price Declines Sometimes Lead the Company to Shut Down ProductionIn September of 2006, Chesapeake announced it would temporarily shut down some of its gas production, in order to hedge against a decline in gas prices. Gas prices fell to around $5.50 per 1000 cubic feet, from around $8 in June[15], possibly due to unseasonably warm weather reducing demand for heating gas. Chesapeake was forced to do the same thing a year ago: in September of 2006, Chesapeake announced it would temporarily shut-in 6% of its gas production, or about 100 MMCfe per day[16]. In order to shut-in production, Chesapeake must give up the use of some of the rigs it has been contracting. Though high oil prices have led to growing rig capacity, driving growth in the oilfield services sector and making it easier for companies like Chesapeake to get back in the game in case of an upturn in prices, there would still be a delay between the price increase and when the company was back at full production. Because of this, Chesapeake's shut-in is risky; reducing production helps margins when prices are low, but at the cost of losing out on greater profits when prices rise. [edit] A Natural Gas Future Would Yield Big Bucks for ChesapeakeNatural gas, as a source of heating energy, is cheaper[17] than oil and more abundant. Furthermore, natural gas can be touted as environmental; in terms of "dirty" emissions like sulfur and nitrogen oxides, natural gas is far cleaner than oil or coal. In 2006, Chesapeake was the third-largest independent natural gas producer in the U.S., with 92% of its daily 1.7 billion cubic feet equivalent coming from the oil substitute[18]. With the vast majority of its business resting on natural gas, the company could end up a huge winner if the energy market swings away from oil and toward this cleaner form of petroleum, as it would have less to lose than other, more oil-dependent competitors. [edit] Increased Production and Higher Cash flowIn the last several years, Chesapeake went on an acquisition binge. The company snatched up land at favorable prices during a time when natural gas prices were falling. CHK funded a significant amount of this land expansion with the use of debt and preferred instruments that eventually convert into equity. This has resulted in the share count doubling over the past five years. Since then, net income has increased five-fold, yet EPS has only doubled. The dilution has caused frustration for some investors. However, share dilution is not always negative. As long as the capital raised from the dilution creates more value than the amount of value diluted, then it’s a positive move. For example, if EPS is $1, but a share issuance doubles share count and reduces EPS to .50, then value will be enhanced when the proceeds generate new $1 EPS, increasing total EPS to $1.50. Dilution caused the outstanding shares to double, yet investors are better off because EPS increased 50%. Chesapeake has completed its land acquisition phase and is now focusing on development of those reserves. Production will increase, and in a pro-rata basis, capital needs should be reduced. Increased production will generate higher levels of cash flow further reducing needs for external capital. CHK has also announced its intentions of using asset sales as a source of funds, and not accessing the public capital markets. Not only will this drastically slow the rising pace of the share count, but enhance value though the asset dispositions. Reserves that have little or no future upside for CHK can be sold at almost 2x the level as implied by CHK’s share price. Going forward, CHK will capitalize on the assets that came at the expense of diluting the equity and produce returns justifying those actions. This should quell apprehension among investors and remove any overhang in the stock price that may have arisen from it.[19] [edit] The "Green Revolution" Could Prove Troublesome to Chesapeake in the Long RunWhether it’s because of the desire for energy independence, the rising price of oil, or fears of climate change, people are becoming more and more disillusioned with petroleum. Environmentalists have been calling for a shift to renewable energy for years, and though the river of change is running slow, it is running deep. Internationally, the Kyoto Protocol has started a shift toward cleaner sources of energy, and though the U.S. isn't partaking Kyoto's changes, the recently passed Energy Independence and Security Act of 2007 is the first step towards a grander series of changes. By forcing automakers to achieve 35 mpg by 2020 and setting a Renewable Fuel Standard of 36 billion gallons of biofuels in 2022[20], the Act could greatly reduce the growth of the petroleum industry - and environmentalists, who have deemed climate change to be "Our Generation’s Defining Moral Challenge", will continue to push for greater change. In emerging markets like China and India, however, the drive for economic growth supersedes environmental concerns. Since emerging markets are growing more quickly than developed economies at the moment, they are where a substantial number of future opportunities in the global economy lay, especially for energy companies like Chesapeake. [edit] Competition
 Chesapeake Energy2004 Data 2005 Data 2006 Data 2007 Data 2008 Data Most Recent Data Available [edit] Notes
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