A weak oil market took a big chunk out of Chesapeake Energy Corporation's (CHKA.Q) fourth-quarter earnings. With low prices persisting into 2015 the company is taking action to preserve its long-term value creation abilities. The company detailed these steps, some of which are pretty remarkable, on its fourth-quarter earnings conference call. Here are five things that particularly stood out.
Refusing to give gas away
Chief Financial Officer Nick Dell'Osso noted on the call that, "in December, we began curtailing approximately 250 million cubic feet of [natural gas per day] in the Marcellus due to low in-basin field prices. Other operators in the area began curtailing gas in the fourth quarter, as well." Long story short, due to low gas prices caused by oversupply in that region, the company simply shut off its wells.
Chesapeake Energy did this because it has "completely redefined the way we thought about that asset," according to Chris Doyle, the company's executive vice president of northern division operations.
We're not going to give gas away. And essentially what we saw was with the in-basin pricing we were better to curtail that [production] than produce into a strained environment. We'll leverage our take away capacity, or take away to get out of basin. And we are seeing really good out of basin realization but we're not going to give gas away in basin.
So the company will produce when it can reap an adequate return by sending its gas elsewhere, but it refuses to produce just to produce or grow just to grow. This focus on value creation is further played out in the company's plans for 2015.
Purposefully holding back growth
Chief Executive Officer Doug Lawler said Chesapeake is "intentionally holding production back in 2015 because we believe it's the prudent thing to do." That not only means production curtailments, but also drilling and not completing new wells. The company's plan is to grow output by 3%-5% next year, though it has the cash and the assets to grow much faster. However, it's only growing in areas where the resulting compensation is adequate, while it is purposefully holding back in areas where it knows it can earn a much higher future return by waiting.
A stunning shift
The shift from growth for the sake of growth to a focus on creating value has been noticeable over the past few years. One reason this shift has been possible has much to do with the step-change it is seeing in well productivity. As an example, Doyle described the advancements at one of Chesapeake's drilling pads,
Franclair pad is a five-well pad, two wells drilled back three years ago and three wells drilled last year. The three wells drilled last year were 7,300-foot laterals versus 6,500. They were drilled in an average of 12 days instead of 33 days. They were drilled for $7.3 million versus $10.8 million. And the average IP [Initial production] of those three wells was 22 million Bcf [billion cubic feet] a day versus 6 million Bcf three years ago. It's a completely different value proposition for this asset. And that I just get real excited. I'm thinking about decades of growth and value coming out of the Marcellus.
That sort of step-change has the potential to create tremendous value for investors over the next few decades, even if the company's operations don't improve much from here.
Attack of the value barbarians
Chesapeake Energy is also known for improving its operations through exceptional cost-cutting. Lawler said this on the matter:
I would say that our cost-cutting efficiency demonstrated in 2014 were like no other in the industry. And I would look to 2014 to the value creation, the value barbarians inside of Chesapeake Energy that are driving further efficiencies and value. And I would expect nothing less than seeing a low-cost operator, the most efficient operator in these assets, and continued improvements in our cost structure.
He calls his team "value barbarians," as the company's employees are intently focused on keeping costs low so that Chesapeake can create more value out of every dollar it spends. As illustrated by the Franclair well pad, these "value barbarians" are delivering noticeable results, which should drive value creation in the years ahead.
Production growth still possible in 2015
While Chesapeake Energy expects its production growth to noticeably slow in 2015, that could change as commodity prices improve. Dell'Osso said increased output was possible if the price situation strengthens. The company has significantly flexibility to quickly restart its growth engine if it can earn justifiable returns. Lawler described the company's ability to grow as a "coiled spring."
"Once we see that it's the prudent thing to do to increase that production we're going to unleash that spring and we will rocket forward and continue to drive a greater value for our shareholders," the CEO said.
Investor takeaway
Chesapeake Energy isn't the same company it was a few years ago. It is focused on creating value, even if that means growth will slow in 2015. However, the company is setting itself up to rocket forward if, and only if, that surge in production will create value for shareholders.
