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Chesapeake Energy Is Finally Drilling Wells That Add Value

Chesapeake Energy (NYSE: CHK  ) has undergone an important strategic shift over the past two years. It has gone from drilling a majority of wells that actually were negative to the value of its reserves, or its PV-10 value to drilling wells that are indeed positive to its PV-10 value. This is a trend that should see the company begin to maximize the value of its assets, instead of working hard just to keep as many assets as it could afford to drill.

No longer drill, baby, drill
Just two years ago Chesapeake Energy drilled 54% of its wells just to hold acreage by production despite the fact that these wells were actually a net negative to its PV-10 value. However, with that drilling largely in the past, the company can focus on drilling wells that add value. As the following slide shows, 85% of the wells Chesapeake Energy drilled in the first quarter were actually accretive to its PV-10 value.

Source: Chesapeake Energy Investor Presentation (link opens a PDF).

As that slide noted, the company continues to drill more wells that are accretive to the value of the company than those drilled just so it doesn't lose acreage. It's a big shift that can help a company like Chesapeake Energy exceed expectations in the quarter, whereas a peer focused on keeping acreage, like Kodiak Oil & Gas (NYSE: KOG  ) , can disappoint.

In the case of Kodiak Oil & Gas, it blamed the rough winter weather for wrecking its first-quarter results as well as knocking it off course from hitting its full-year guidance. However, the real reason the company disappointed investors was because of its focus on drilling weaker acreage just so it could be held by production. Kodiak Oil & Gas CEO Lynn Peterson noted that:

During the first quarter of 2014, nearly a third of our completed operated wells were drilled in our Wildrose area of northern Williams County to hold acreage. This is an area with a thinner reservoir section and less source rock that results in lower reservoir pressures and less gain, and corresponding lower production rates and reserves.

What Kodiak Oil & Gas experienced in the first quarter used to be the story at Chesapeake Energy. However, the company can now instead focus nearly all of its attention on its best acreage.

The end results
Because it can focus on optimizing its drilling, Chesapeake Energy will be able to drill 90% of its wells on pads this year. That's up from 70% in 2012 and is akin to drilling the same number of wells with one fewer rig working. At the same time, the company can also focus on drilling longer laterals, which it is drilling faster than ever. Here, the company is drilling the same number of wells, but saving the equivalent of more than six rigs, as the following slide shows.

Source: Chesapeake Energy Investor Presentation.

The numbers are pretty staggering as Chesapeake Energy's drilling efficiency program alone saved the company $470 million in the first quarter of this year compared to 2013.

Meanwhile, Chesapeake Energy continues to focus on getting better at drilling its wells. Another example of this is improved geosteering, which is enabling 94% of its laterals to be drilled in the target zone versus 87% two years ago. That might not sound like a lot of improvement, but as the following slide shows, it is having an impact.

Source: Chesapeake Energy Investor Presentation.

This focus adds an incremental 26 million barrels of oil equivalent to the company's reserves each year, which can add an annualized $330 million to the company's PV-10 value.

Investor takeaway
Chesapeake Energy is finally able to focus most of its attention on drilling wells that add value instead of drilling just to drill, a strategy that is having a profound impact on Kodiak Oil & Gas. This focus is enabling Chesapeake Energy to invest to drill the best wells as well as invest in the technology needed to make these wells even better. The move is a real big positive for its investors. 

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Matt DiLallo

Matthew is a Senior Energy and Materials Specialist with The Motley Fool. He graduated from the Liberty University with a degree in Biblical Studies and a Masters of Business Administration. You can follow him on Twitter for the latest news and analysis of the energy and materials industries:

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8/31/2015 3:52 PM
CHK $7.78 Up +0.39 +5.28%
Chesapeake Energy CAPS Rating: ****
KOG $0.00 Down +0.00 +0.00%
Kodiak Oil & Gas C… CAPS Rating: *****