Is Chesapeake Energy Corporation About to Repeat its Biggest Mistake?

After years of focusing on liquids, Chesapeake Energy Corporation is looking to drill for more natural gas.

Feb 25, 2014 at 7:00PM

Chesapeake Energy Drilling Rig

Photo credit: Chesapeake Energy Corporation 

The Haynesville Shale was once one of the hottest new natural gas plays. Because of that, companies like Chesapeake Energy Corporation (NYSE:CHK) poured billions of dollars into the play, causing gas production to surge. The problem was that once the bubble burst on gas prices, so did the enthusiasm for the Haynesville Shale.

Things got so bad for Chesapeake Energy that the Haynesville Shale was one of the areas where it sold acreage in order to bridge its funding gap. Last year it unloaded 5,600 net acres in the Haynesville to EXCO Resources Inc (NYSE:XCO) for $320 million. The deal included interests in 170 wells that EXCO Resources already operated, as well as some drilling sections that Chesapeake Energy operated. While the deal made sense for both companies at the time, Chesapeake Energy was still viewed as a forced seller, suggesting that it didn't get as good a price as it could if it waited until natural gas recovered.

A turnaround is under way
Now that we are seeing a recovery in natural gas prices, we're seeing a bit of Chesapeake Energy's enthusiasm for the Haynesville Shale return. Chesapeake Energy, which discovered the Haynesville Shale in 2008, is returning its attention to growing production from the play. The company noted earlier this month that it was planning to spend 10% of its capital budget to fund seven to nine rigs in the play. That's a 25% increase from last year. It's a plan that had analysts scratching their heads and investors wondering if the company is about to repeat its past mistake.


Photo credit: Chesapeake Energy

On the conference call with analysts, one noted that the company gets better returns in the Marcellus Shale, which made him wonder why the company would now turn its attention to the Haynesville. Chesapeake Energy CEO Doug Lawler, however, reminded everyone that the "Haynesville asset is just simply a world class." However, he also noted that it has not yet been optimized the way the industry has optimized other plays. Because of this he sees the opportunity to see significant cost improvements and therefore higher returns. For Chesapeake Energy that makes the Haynesville Shale a much more competitive investment for the company than investors realize. 

Falling costs yield higher returns
Chesapeake Energy believes it can get its drilling costs down to $7.9 million per well this year. That's 23% less than the $10.3 million cost per well it spent just two years ago. The use of multi-well pad drilling will play a big factor in bringing these costs.

With a little more work the company likely could get those well costs down even further. EXCO Resources, for example, achieved record low average drilling costs of $7.5 million per well in the third quarter. Lower well costs, when combined with wells that are producing higher volumes, can indeed produce solid returns. For example, a natural gas price of $5.00/mcf could yield a return over 100% with well costs of $7.9 million for Chesapeake Energy.

Why this might not be a mistake
While natural gas prices are high now thanks to the rough winter experienced by much of the U.S., one bad winter isn't exactly a long-term trend. What is a developing long-term trend is natural gas exports, with Cheniere Energy (NYSEMKT:LNG) expected to begin exporting natural gas from its Sabine Pass LNG terminal late next year. That terminal just happens to be located in Louisiana, the same state as the Haynesville Shale.

 Cheniere Energy Sabine Pass Lng

Cheniere Energy Sabine Pass LNG. Photo credit: Flickr/Roy Luck

There are a number of LNG export facilities planned along the Gulf Coast, including a second facility by Cheniere Energy in Corpus Christi. These facilities will need to be supplied with natural gas, with the Haynesville Shale being strategically located to benefit from exports. This suggests that Chesapeake Energy and even EXCO Resources could benefit from investing in the Haynesville to ramp up production ahead of these facilities being built.

Investor takeaway
The Chesapeake Energy of today is a much different company than the one that went all in on natural gas a few years ago. Today the company is investing within its cash flow and keeping its costs down. That's why I don't see the company's move to invest to grow its gas production from the Haynesville Shale being a repeat of a previous mistake.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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