Will Chesapeake Energy Corporation's Utica Shale Bet Backfire?

Despite poor results from several Utica shale drillers, Chesapeake Energy’s numerous competitive advantages in the play should ensure strong and profitable growth.

Jun 1, 2014 at 4:24PM

Chesapeake Energy (NYSE:CHK) recently held its first analyst day since new CEO Doug Lawler took the reigns last year. One of the key takeaways from the conference was management's greater optimism regarding Ohio's Utica shale, which it called its "newest world-class asset."

Chesapeake expects the emerging play, where it is one of the largest and most active leaseholders, to be a key driver of its liquids production growth and plans to more than double its current Utica production level by year-end. But given the recent departure of some high-profile operators because of the Utica's higher-than-expected dry gas content, will Chesapeake's renewed focus on the play pay off?

Pipeline Construction

Source: Flickr/Vicki Watkins.

A change of heart in the Utica
While the industry had extremely high hopes for the Utica initially, with former Chesapeake CEO and founder Aubrey McClendon calling it "the biggest thing to hit Ohio since the plow," the bullish sentiment has died down considerably after some operators' test wells suggested the play contains more dry gas and fewer liquids than initially believed.

Companies including BP (NYSE:BP), Hess (NYSE:HES), and Halcon Resources (NYSE:HK) have added to the negative sentiment in recent months. BP said last month that it is scrapping plans to develop its nearly 100,000 acres of Utica shale leasehold following poor appraisal results from test wells. The British oil giant took a $521 million write-off associated with its Utica holdings for the first quarter of 2014.

Hess, meanwhile, struck an agreement to sell 74,000 mainly dry gas Utica acres to American Energy Partners LP, which, ironically, is led by none other than Aubrey McClendon, for $924 million back in January. Hess has been busy divesting non-core assets in order to reduce its debt, repurchase its stock, and focus on its most promising opportunity in North Dakota's Bakken shale.

Halcon Resources, which commands 139,000 acres in the Utica, also doesn't seem too optimistic about the Utica. The company recently said it would suspend its drilling program in the play this year, citing worse-than-expected test results in the northern portion of the Utica and more attractive opportunities in North Dakota's Bakken shale and Texas' El Halcon basin.

But unlike BP, Hess, and other operators that have exited the Utica, Chesapeake enjoys numerous advantages in the play, including an industry-leading cost structure, extensive technical expertise, and improving infrastructure that should allow the company to significantly ramp up production and also generate much stronger returns.

Chesapeake's competitive advantages
Chesapeake is one of the largest leaseholders in the Utica, with over 1 million net acres under its belt. To date, it has drilled 485 Utica wells, of which 274 are currently producing. The company is currently pumping around 75,000 barrels of oil equivalent per day (boe/d) in the play, which is already up 50% compared to a first-quarter average production level of 50,000 boe/d.

By the end of the year, Chesapeake expects its net Utica production to exceed 100,000 boe/d. Not only is the company's Utica production poised to grow rapidly, but its operations in the play are now much more profitable than they were just a couple of years ago, thanks largely to major reductions in well costs and the number of days it takes to drill a typical well.

The company expects its typical Utica well to cost just $5.7 million by year-end 2014, down significantly from $7.7 million in 2012 and $6.7 million in 2013. Average drilling days have also fallen from 24 days in 2012 to 20 days last year to a projected 15 days by the end of this year. By comparison, the average Utica operator spends $11.8 million per well and takes 35 days to drill and complete a well.

As a result of this huge production cost advantage, the company's returns from the play are exceptionally high. Assuming a wellhead gas price of $4.50 per Mcf and an oil price of $95 per barrel, Chesapeake's Utica wells generate rates of return ranging from of 65% to a high just north of 80%, which even compare favorably to world-class plays such as the Eagle Ford and Bakken.

Overall, the company expects its Utica drilling program to generate a 45% rate of return this year, up from just 20% last year. By next year, that figure could rise to as high as 60%. Chesapeake also now has a major infrastructure advantage in the play thanks to the recent start-up of the ATEX pipeline, on which it has firm transportation commitments. This ensures its production can get to market at low cost.

Investor takeaway
Chesapeake's renewed focus on the Utica shale holds much promise for the company, given major cost improvements over the past two years. With production from the play expected to double by the end of the year, investors may want to keep an eye out to see whether production and returns match up with the company's projections, since any disparities would have a meaningful impact on its production and cash flow outlook.

3 stock picks to ride America's energy bonanza
Record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a look at three energy companies using a small IRS "loophole" to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report "The IRS Is Daring You To Make This Energy Investment." Don’t miss out on this timely opportunity; click here to access your report -- it’s absolutely free. 

Arjun Sreekumar owns shares of Chesapeake Energy. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information