Chesapeake Stops Worrying and Learns to Love Low Gas Prices

Chesapeake Energy (NYSE: CHK  ) CEO Aubrey McClendon caught me off guard a bit with this comment on the firm's year-end conference call:

"The lower gas prices go today, the better it is for Chesapeake."

Sounds crazy at first, sure, but the country's leading natural gas producer does have a lot of factors working in its favor.

Chesapeake's got a dominant position in each of the top shale plays -- what it now refers to as the Big Four. From the Haynesville to the Marcellus, these are low-cost leaders that ought to generate strong rates of return in today's environment. That's a strong part of the equation, and a reason look to favorably on neighboring players like Encore Acquisition and Range Resources (NYSE: RRC  ) .

By hedging its production to the tune of 80% in 2009, Chesapeake gets the best of both worlds: gas price realizations that don't fall, and service costs that do. On the call, the company said it is "renegotiating rates downward with every vendor, large and small on every new well." That's bad news for folks like Halliburton (NYSE: HAL  ) and Baker Hughes (NYSE: BHI  ) , but great news for those with the ability to keep drilling.

Speaking of which, Chesapeake has partners doing a lot of the heavy lifting on that front. The company structured its joint ventures with Plains Exploration & Production (NYSE: PXP  ) , BP (NYSE: BP  ) , and StatoilHydro (NYSE: STO  ) in such a way that Chesapeake's share of the drilling costs are covered by the partner at the outset. In the Fayetteville JV with BP, for example, this "carry" should last until the end of the year.

All told, that's $4 billion being spent on Chesapeake's behalf -- and the further service costs drop, the further those drilling dollars go. Service costs dropping are a direct response to lower gas prices and field activity, so it's no wonder Chesapeake's gotten to love low gas prices.

Chesapeake is an Inside Value selection. StatoilHydro is an Income Investor pick. Dig into any of our premium subscriber newsletters free for 30 days.

Fool contributor Toby Shute doesn't have a position in any company mentioned. The Motley Fool has a disclosure policy.


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  • Report this Comment On February 20, 2009, at 3:55 PM, susan400 wrote:

    McLendon and the author might be bucked up,":who me worry " but Ngas traded under 4$ today, they have near no 2010 hedge protection, '09 hedges were put on long ago in afar higher price enviornment.

    If gas stays sub 5$ gas, looks like CHK is in deep dodo and less leveraged players would survive.

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