Chesapeake Energy Corp.
A Man of Constant Sorrow

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By tjo14
October 13, 2005

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I cannot share the enthusiasm of Chesapeake Energy over the prospects of drilling for Appalachian gas. Chesapeake recently purchased CNR from Triana for 7 times the price Triana paid 2 years ago. I think they paid way too much, and I don't think they will have success drilling in Appalachia, because the place is pretty much tapped out.

Chesapeake said that one of the reasons for moving into Appalachia is the 98% success rate of the wells there. I drilled gas wells in Appalachia for 10 years. It is a popular myth that the wells there have a "98% success rate." It is true that most of the wells there are put on production and connected into a pipeline. However, this does not mean that most of the wells in Appalachia are a commercial success. In fact, the commercial success rate is about 15%. And the occasional success does not make up for the failures.

Why is this? In most normal parts of the gas producing world, you can determine if a well will be commercial after spending about 60% of the total well cost. But in Appalachia, since the producing formations are so tight, you have to run production pipe and fracture the well before you can determine if the well is commercial. After doing this, you have sunk about 90% of the total cost. All you have left to do is run a short pipeline to "turn the well in." This is why such a high percentage of Appalachian wells are put on production and counted as a success, even if they produce no more than a popcorn fart. The commercial success rate of development wells in Appalachia is equivalent to the success rate of test wells in normal parts of the producing world.

Chesapeake has been quoted as saying that the Appalachians are dominated by "Mom & Pop" companies, and a large company like Chesapeake should be able to profitably find more gas. There is a reason the basin is dominated by Mom & Pop companies. There has been a succession of large companies that move into Appalachia thinking it's going to be easy pickings. Chesapeake is only the most recent. They generally give up and move out after a few years, selling their production to Mom & Pop companies at a loss. It will take Chesapeake about 3 years to figure out that they can't make any serious dough in the Appalachians. Then, today's great idea to buy CNR will be tomorrow's great idea to sell it. Wall St will cheer both times because, what do they care, they are just in it for the commission. Falling gas prices will be blamed. But I will be there to remind you that I predicted that Chesapeake would sell CNR at a substantial loss.

It is true that the sale of CNR for way more than it's worth could cause a temporary over-valuation of other Appalachian companies. But I do not recommend investing in an industry that is based on running a 15-minute well test after pressuring up the well for a month.

Investing in Appalachian gas will make you a man of constant sorrow.

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