Chesapeake Energy is one of the largest independent natural gas companies in the U.S. Chesapeake has expanded by concentrating its capital in just a few geographic regions, allowing the company to gain an in-depth knowledge of the surrounding geology that has kept drilling success rates above 97% since 1991, and at 99% in 2008 and 2009. With drilling focused on a few key regions, the company also actively acquires new reserves that it thinks could yield in the future. Since 1998, Chesapeake has the largest inventories of onshore leasehold and 3-D seismic in the U.S., with 38,000 net drill sites representing over 10 years of inventory for drilling projects. 
Though much of the company's previous growth was financed through debt, Chesapeake has sold assets that did not fit its long-term goals, a plan that allowed the company to spend on exploration and drilling without borrowing money. That strategy effectively reduced the company’s level of risk. With natural gas prices on the decline, in April of 2009 the company cut production by 13%. Production was cut in order to sell in the future, when prices are expected by investors (reflected in higher NYMEX forward strip natural gas prices) to be higher due to increased economic growth. Looking forward, lower gas prices during warmer winters depress margins. In the medium to long term, renewable energy has the potential to take away demand from oil and natural gas. Natural gas has been touted as the next big fuel, as it burns cleaner, more efficiently, and can be cheaper than oil. 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, but gas isn’t cleaner than renewables like solar and wind, which are getting cheaper every day.
Chesapeake's sale of the Kerr-McGee property in July 2007 highlights a major part of its new growth strategy. By selling off some of its properties and rigs, the company can use the resulting cash to grow without increasing its debt. The company has a drilling and completion capital expenditures budget of $4.2 billion to $4.5 billion for the year 2010, which the company believes it can fully fund with its cash flow and asset monetization strategy.
On January 6, 2011, Chesapeake issued a press release revealing its "25/25 Plan," in which it plans to reduce its long-term debt by 25% over the next two years, while sustaining a production growth rate of 25%. To add certainty to this plan of reducing debt, Chesapeake also has hedged 96% of its projected natural gas production for 2011, locking in an average price of $5.84 per thousand cubic feet, a strong price in comparison to current market prices and even a premium to January 2013 futures. If prices rise drastically in 2011, Chesapeake could lose out on great profit, but the company values its ability to lock in its cash flows and plan its growth. Chesapeake has continually been taking strides to fund its growth internally--the "25/25" plan further proves the company's determination.
In January 2011, as a follow-up to a $1 billion shale deal in south Texas between Chesapeake and CNOOC, Ltd. (CEO) in October 2010, CNOOC, Ltd. (CEO) purchased an additional $570 million in shale assets in Wyoming and Colorado from Chesapeake. In February 2011, BHP Billiton (BHP) agreed to purchase Fayetteville shale properties, part of the Arkoma Basin in Arkansas, from Chesapeake for $4.75 billion. Chesapeake has started off 2011 with big sales, holding true to its plans of funding growth internally.
As a supplier of oil and natural gas, Chesapeake's revenue rises and falls with commodity prices. Oil and gas prices have fluctuated heavily over the past few years--after oil peaked at a price of $145.85 per barrel on July 3, 2008, there was a steep drop in prices, with oil averaging at $62 per barrel in 2009.
When oil and gas prices fall, Chesapeake suffers. Expecting continued high prices in 2008, the company invested heavily, boosting production from unconventional, expensive-to-produce reserves to 1000 Bcfe per day, but invested just as much in the rest of the year, announcing in June 2008 a $178 million JV with Goodrich Petroleum to develop the Haynesville Shale. However, when prices started to decline, Chesapeake was forced to liquidate some of those reserves to finance continued expansion and to maintain production of 980 MMcfe per day out of its conventional reserves, which are much cheaper to extract from than unconventional reserves.
As prices rise, so does Chesapeake's revenues. After a period of decreasing net income from 2007 to 2008, Chesapeake's revenues started showing growth again in 2009. As of February 17, 2010 CHK has entered into hedging programs to eliminate some of the price volatility of natural gas. Currently approximately 60% of estimated production for 2010 has been collared, with a floor and a ceiling for prices put in, at an average price of $8.16 per mcfe, which is a significantly better price than CHK received during 2009 when natural gas prices plummeted, but it also means that a CHK could be left out of a possible rebound.
The active rig count in the United States reached a peak at 1,606 rigs in the second half of 2008, but over the first half of 2009 companies had scaled back oil and gas drilling operations due to falling commodity prices and restriction on access to credit, and the active rig count began to decline until it reached below 900 in the summer of 2009. Since then, however, drilling activity has increased, and is a sign that companies are bringing oil and gas rigs back online and could be a signal of industry stabilization and improvement. Continuing in its rebound from 2009 levels, in the first quarter of 2010, the number of active rigs in the United States was 1,419, a 314 increase from the 1,105 rigs in the same period in the previous year.
With the company's production in the resource at over 400 MMCfe net per day, the Texas Barnett Shale, 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 sign that Chesapeake has a long-term commitment to developing the Barnett Shale, it has entered into a $2.25 billion agreement with Total S.A TOT. As part of the terms of the agreement Total will give $800 million to Chesapeake upon closing of the deal, and will acquire a 25% stake in Chesapeake's upstream Barnett Shale holdings. Additionally Total will pay 60% of the development and operation costs of Barnett Shale projects, up to an upper limit of $1.45 billion.
On November 29, 2010, Chesapeake Energy paid $200 million to Australia's Antares Energy Ltd for the right to drill on 23,180 acres in the Eagle Ford Shale area in South Texas. At a price of $8,628 per acre, Chesapeake paid a premium of more than 20% over the average regional price in the past year.
Congress is currently examining the possibility of banning "fracking". "Fracking" refers to the process where water, sand, and hydraulic fluids under great pressure are used to create fractures that allow the gas to be collected. The method is widely used to collect natural gas, especially from the Marcellus Shale which is thought to contain 500 trillion cubic feet of natural gas. The method has come under fire, because it is thought that the chemicals and fluids used to fracture the shale contaminate nearby water supplies. This contamination has led congress to investigate a ban on the method .
This is a key method through which natural gas companies are collecting gas and oil from shale reserves. Its importance is highlighted by the fact that Exxon-Mobil's $31 billion dollar takeover of XTO would be terminated if congress were to prohibit or make "fracking" commercially unviable.
In 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 double the level 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.
Whether 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, 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.
The 9.0 magnitude earthquake in Japan on March 11, 2011 and the following tsunami caused four nuclear power plants in Northern Japan to fail, leading to radiation release and overheating in the reactors. Japan has closed 11 of its 54 reactors since the earthquake, with the government struggling to prevent a nuclear meltdown. As a result, confidence in the future of nuclear energy has been shaken, while confidence in solar energy and natural gas has renewed. Many view natural gas as a cleaner, safer, and abundant energy source, with a demand that is growing.