Chesapeake Energy Corporation (NYSE:CHK) has taken another big step forward to reduce its costs so that it can increase the margin it's earning on its natural gas production in a low price environment. That step is in the form of a new gas gathering agreement with its midstream partner Williams Companies (NYSE:WMB) and its MLP affiliate Williams Partners (NYSE:WPZ) in the Haynesville and dry gas Utica shale. The new deal will lower Chesapeake Energy's costs so that it can drive volume growth in both of those plays.
Doing what it said it would do
On its second-quarter conference call, Chesapeake Energy CEO Doug Lawler said that the company was having "positive discussions with Williams, our primary gas gathering provider," on a new gas gathering agreement and that he was "confident in finding mutually agreeable solutions that will benefit both companies." Today, that confidence has been rewarded as the company has finalized two very important agreements with Williams.
There are three primary attributes to this deal:
- Chesapeake will see a significant improvement in its per unit gathering rates in these two areas beginning in 2016.-- This will lead to enhanced volume growth for Chesapeake, which also benefits Williams
- The combination of the gathering system agreements allows Chesapeake to satisfy minimum volume commitment (MVC) obligations in the Haynesville Shale. -- This will lead to an increase in the realized pricing per mcf of gas.
- The aligned strategic interests improve drilling economics, operational efficiency, and midstream asset utilization.
It's a win-win solution for both companies as Chesapeake Energy will enjoy the benefit of lower gathering fees, which will improve margins. This will provide it with more cash flow so that it can grow faster. Meanwhile, Williams and Williams Partners benefit because they'll earn a fixed fee across a larger volume of gas that will run through the system as Chesapeake increases production.
Every penny counts
As the slide below shows, Chesapeake Energy will enjoy a steady improvement in its Haynesville gas differentials starting next year.
The net result of the improved gathering rate due to this agreement plus the increase in capital spending Chesapeake will allocate to the Haynesville is expected to drive a $200 million increase in annual EBITDA from this play. That's a big boost as that represents roughly an 8% increase on the company's current adjusted EBITDA run rate.
In addition to the benefit in the Haynesville, Chesapeake will also enjoy a much lower gathering rate in the Utica shale. It expects the gathering fee to drop from its current rate of roughly $0.67/mmbtu to an average of $0.41/mmbtu next year, all of which basically falls to the company's bottom line. The combination of this lower rate plus the opening of a new pipeline to take its gas to the Gulf Coast, will result in a significant improvement in that play's economics as well.
By adjusting its two gathering agreements with Williams, Chesapeake Energy has locked in a lower rate for gathering its natural gas. This will really improve the economics of both plays, enabling Chesapeake Energy to grow its volumes at a higher rate than before. That benefits Williams and Williams Partners as they will then be earning that fixed fee across a higher volume of gas. That makes it a real win-win for both companies as Chesapeake Energy gets out from what was becoming a burdensome contract in the Haynesville so that it can really drive stronger growth from that asset in the years ahead.
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.