[emersonbiggins]

Interesting take, Rockman. I have to say that your take on this makes more sense to a layman like myself, than the official line.

I listened to yesterday's CHK conference call this morning (on their website), and heard a few interesting mentions:

- Of the $3.2B in capex cuts for CHK, 40% comes from the [partial?] divestiture of the Fayetteville and Marcellus plays, with the remaining coming from other plays, specifically those in OK (which is MOL shut-in at the moment).

- CHK has, for three years running, shut-in (125-150 mcf/day - I think??) production during times of seasonal low price, e.g. "now."

- Most of CHK's UC plays are uneconomic below $7.50 wellhead.
CHK is heavily hedged at a price of $8-9, which tends to ameliorate the rapid swings on the spot market.

Perhaps the most informative, for myself:

- First-year decline curve for most all gas plays (shale/sand/horizontal, etc.) is at least 60% and as high as 85%.

Obviously, ROI must be very quick for these things to be profitable. And apparently they are.

[BigTex]

I think that totally ignoring everything CHK said would be easier than trying to make any sense out of it.

We may well see some kind of natural gas bust like we saw with oil in the early 1980s. I think the whole thing will happen a lot more quickly, though. I'm thinking 2-3 years of extremely low prices at some point that makes everyone in the business go broke, and then sustained high prices following that, right about the time a bunch of natural gas vehicles start rolling off the assembly line. I'm thinking instead of 20 years of low oil prices following the 1980s bust, we might see this 2-3 year period of low NG prices, followed by much tighter supplies and sustained higher prices.

I don't know a lot about these new natural gas drilling techniques, but it seems clear that for a short time we will be able to dramatically increase domestic natural gas production. However, it seems like that may just set the stage for the scenario I describe above.

ROCKMAN or anyone else, what are your thoughts on how long any surge in domestic NG production might last (or can last)? I know very little about this topic, so any help is appreciated.

[ROCKMAN]

Exactly emerson. I've outlined before the trap companies are willingly running into with respect to the UNG plays. This includes my current client as well. The ROI is adequate but only because of the high initial flow rates. Any well that pays out in less then 12 months has a ROR over 100%. But if it depletes after 3 or 4 years of rapid decline rate it may only recover 2X the initial investment. Still not bad...wish I had all my savings in such an investment.

But the trap is what I've referred to as "corporate PO" or corporate PNG in this case. Public oils have to show the potential for y-o-y reserve increase. This isn't hypothetical. Back in the late 70’s a public TX company (UPRC) committed corporate suicide by drilling over 600 SUCCESSFUL oil wells in another resource play (the Austin Chalk). Same production profile: high initial flow rates and rapid declines. Their stock price shot up as long as they were drilling and replacing those rapidly depleting assets. But they drilled up all the locations and had nothing to replace their reserve base. The stock tanked just as quickly as it rose and they were eventually sold for scrap.

CHK cannot stop drilling UNG for any significant time period. If they do the reserve base will drop quickly followed by the stock price. Maybe they’re at that point now. I don’t study there numbers in detail so I can’t guess. But I will tell you eventually every UNG player will face the day when they can’t drill fast enough to replace declining reserves. Simple geometric progression: for every well they drill to replace declining production they have to drill another well to replace the replacement well. This brings me full circle back to the capital question: in the tightening credit market we see today is CHK having difficulty securing financing? I don’t know but I have my suspicions. We may actually see some other companies pulling their horns back in for this reason. But if they do I’ll bet they offer every reason other than the truth to explain it. I’ve spent many hours in many board rooms trying to generate just the right spin to hide an ugly truth.

And I’ll make the point again for your benefit. PO is not an unrecognized reality in the oil patch. It’s been the center of most companies’ biz plans for over 15 years at least. We just never called it PO. It’s always been the “reserve replacement” issue. The folks at CHK understand PO or PG just as well as the rest of us. Every CEO in the oil patch knows the story of UPRC very well. But would expect all these CEO’s to get up at their annual meetings and go into detail about how the domestic industry is dying a little every day? How the day will come (as it has for ExxonMobil, Chevron and Shell about 2 years ago) when they are no longer able to stop the shrinkage of their asset base? One of the key tools used to offset PO has been to buy other companies’ assets. Not 2 months ago XTO bought Hunt Oil for $2.4 billion. I would bet you lunch that CHK was one of a number of unsuccessful bidders for Hunt. And I would win. Acquisitions and Divestitures was my focus throughout the 90’s. The only question now is who is going to buy who. Who knows…maybe CHK is saving their capex so they can flop $5 or $10 billion down on the table and buy someone in the next 6 months. I can tell you for certain that every big US independent company has an active and aggressive acquisition team working long hours looking for the next deal.

[ROCKMAN]

Tex,

To get a clear picture you have to separate the new UNG gas wells from the old heritage production. Not too difficult given that the upswing in NG production has been solely the result of UNG. The one big exception would be the Deep Water NG fields but they also have a rather steep decline rate (like 80% in 5 or 6 years). At a minimum the UNG wells typically decline at 50% the first year. Some much quicker. If all UNG drilling stopped today you would see NG production dive over the steepest cliff ever seen in the oil patch since Col. Drake poked that first hole. This is not an exaggeration in the least bit. See my story about UPRC above. In that sense I agree with you about any short term price drop in NG prices. But I'll also point out that every public company in the UNG plays will keep drilling as long as they have the capital. Even if they know they only get back $1 for every $1 spent. If you disappoint Wall Street they will cut your throat in a heart beat and leave you dying in the gutter (been there and felt the knife blade). I don't mean this to sound so negative but it really is something of a ponzi structure. If you're holding the stock when the market realizes the company has reached that tipping point then you loose.

[emersonbiggins]

Thanks again, rockman, for the very thorough response.

Speaking to capex going forward, one of the takeaways from the call was that CHK was looking at taking on some of the midstream work (I assume this to be the processing of NG for various uses) , so as to protect their margins in the huge new plays like the Haynesville.

[BigTex]

So in a sense, natural gas is sort of like a microcosm of the depletion characteristics of oil--high prices lead to increases in production, which increases the steepness of the eventual production decline curve.

It's funny, but in a rational world high prices should SLOW DOWN production (high prices being a signal that a finite resource is becoming harder to find). In the real world, however, high prices dramatically increase the the rate of production...for a while...and then the increased production either declines dramatically as finite limits are reached or the increased production destroys the market for the commodity, in which case the producers basically slit their own throats. What is ironic is that the story ends the same way under either scenario--producers out of business and the economy in shambles. This process plays out slowly enough that no one really realizes it is happening, and they are getting very rich during the good years.

With natural gas, though, we may have a chance to see the process unfold over a much shorter period. I would love to know what the price of natural gas will be in 10 years.

[ROCKMAN]

You're welcome emerson. There are many things I don't know much about but there are a few things I understand well. I'm just glad to be somewhere I can share that knowledge w/o sending someone into a boredom induced comma.

[copious.abundance]

Is there a possibility that (at least one) reason Chesapeake is curtailing their rate of drilling is because they've having a hard time selling all that gas? Regardless of the price and other issues, with NG production up something like 7% this year, I have a hard time believing that consumption could also be rising that fast (and noting historically high storage rates of late as I mention this).

It's possible for even McDonald's to produce too many burgers and Starbucks to produce too many lattes, even if they were practically giving them away. There's gotta be a limit at which you can increase your rate of consumption of something, even when the price is dirt cheap. Seems to me the same would be as true of NG as anything else.

In June, for example, the US produced 2.1 tcf but only consumed 1.6 tcf, and we've produced more than we've consumed for several years in a row. I mean - c'mon, there's gotta be a limit at which producers can over-produce, and thus, not be able to sell.

[ROCKMAN]

I guess its all in the wording OF2. Lack of a market to sell into is not "curtailing" by most folks definition. Curtailing implies a voluntary cut back. Lack of sales market is lack of sales market...nothing voluntary about that. But this is why the corporate lawyers approve all press releases. As far as the imbalance between production and consumption remember this is also the season when NG is being sent to storage for winter consumption.

But, yes, operators can generate so much new production in one area as to push pipelines to their capacity. This happened in the Rockies last winter and producers paid a heavy price for it. If they didn't have transport contracts already in place they either had to shut in wells or take rediculously low prices.

[allenwrench]

In Chesapeake Energy's commercials, they assure the public that our domestic nat gas resources are in good shape for another century.

They even go so far to speculate they may be limitless.

Can Chesapeake Energy be trusted?

[joeltrout]

I don't trust Chesapeake as a mineral owner, as a working interest partner, or as an investor.

joeltrout

[coyote]

They likely mean 100 years "at current rates of consumption." That's how these numbers are usually given, and it's always disingenuous as hell. Especially, in this case, with all the buzz about building a CNG auto fleet. Consumption should go through the roof, especially with high oil prices.

But really, if they even use the word "limitless," then that should give a good indication of the overall quality of their statement, shouldn't it?

We do seem to have an awful lot of natural gas in North America, though. Lucky for us...

[ROCKMAN]

Sure you can trust CHK...just like all the folks that trusted all those real estate agents who said not to worry about adj rate mortgages: real estate price increases will cover it.

And this from me, a geologist working with one of the biggest unconv NG drillers in the country. UNG is a great boon to our economy but throwing out prediction such as the CEO of CHP w/o consumption and pricing assumptions is less than worthless. His words are potentially damaging to future planning.

[3aidlillahi]

$this->bbcode_second_pass_quote('coyote', 'T')hey likely mean 100 years "at current rates of consumption." That's how these numbers are usually given, and it's always disingenuous as hell. Especially, in this case, with all the buzz about building a CNG auto fleet. Consumption should go through the roof, especially with high oil prices.

But really, if they even use the word "limitless," then that should give a good indication of the overall quality of their statement, shouldn't it?

We do seem to have an awful lot of natural gas in North America, though. Lucky for us...

[Tyler_JC]

My friends and I came to the same conclusion.

We run a modest (very modest) investment portfolio for the university and we're trying to add another energy company to the mix.

Currently we're deciding between Anadarko and XTO.

We cut Chesapeake from the list of potentials early on. They somehow managed to lose money this year despite record revenue.

They are too heavily invested in risky projects and spend far too much time hanging around T. Boone Pickens.

The company seems dependent on politics and not profits.

To the larger quesiton:

Chesapeake, T. Boone Pickens, and the rest are part of the Natural Gas Conspiracy.

They want to replace oil with natural gas, believing that we have a lot more NG than the current reserve numbers would indicate. They might be right.

The conspiracy isn't necessarily bad thing. It's just something we need to consider when thinking about Peak Oil.

We should acknowledge who the players are, what their motives are, and look into the validity of their plan.

There are many plans just like this one. Some will work, some will not. Clean coal, hydrogen fuel cells, and corn ethanol have managed to attract a lot of attention as well.

As we move down the oil production curve, we're going to see a lot more money thrown at alternatives.

[ROCKMAN]

Tyler,

For what it's worth I don't think NG has any real potential to replace oil in the transportation sector. Several reasons. First, scalability - just too much capital to convert cars and build distribution infrastructure in any time frame that's reasonable. I doubt your building a portfolio on expectations 30+ years out. PO will likely impact transportation significantly long before CNG vehicles make up even 10% of the market. Secondly, PNG. Yep...same problem as with oil. All the UNG players, including mine, face the same problem: rapid depletion rates. The UNG wells are getting much better flow rates these days but they still suffer from very rapid decline rates. You've seen the rise in NG production rates but they are not sustainable with out even more drilling. Regardless of how many UNG locations there are to drill (and there are probably 100's of thousands of them as long as NG prices stay north of $7/mcf) there will come a point where the UNG players will not be able to stop y-o-y reserve base decline. Regardless of the good economics, an infinite number of drilling rigs will not be built.

At that point the only remaining measure to justify stock price is dividends. Now this strictly refers to expanding the NG reserve base with the drill bit. Acquisitions is another way to offset a declining base. Likewise, conventional oil exploration can have its place with some of the NG companies.

I see a closer link between NG and coal prices in the future. They'll likely compete for the electrical generation market to even a greater degree IMO. I've read that part of the reason for the NG price run up last spring was the advance in coal prices. I don't track such markets but it seemed a reasonable explanation.

Out of curiosity, have you researched dvn?

[Tyler_JC]

Hmm..

Devon Energy's numbers don't look significantly better than APC and we've already done all of the research for APC...and made the power points presentations...

I'd have to bring it up with our lead analyst but it's definitely a good back up stock if they vote down Anadarko.

Thanks for the advice.

[ROCKMAN]

I just mention dvn because they were so beaten down with the rest of the market yesterday (hit $68 at the lowest bid). Less than 6 months ago they were $127 and all the analysts loved them at that price. The industry still has a lot of NG shutin in the GOM that should be going to winter storage right now. DOE also predicted residential NG prices to be 30 - 50% higher this winter. DVN is mostly a NG player but just announced a 40% WI in an offshore Brazil pre-salt discovery operated by Anadarko.

[Snik]

$this->bbcode_second_pass_quote('allenwrench', 'I')n Chesapeake Energy's commercials, they assures the public that our domestic nat gas resources are in good shape for another century.

They even go so far to speculate they may be limitless.

Can Chesapeake Energy be trusted?

[ROCKMAN]

CHK may rank #3 in NG production rate in the US but the are essentially tied with independents Devon and Anadarko when you look at proven NG reserves. This means their reserve base is declining faster than any of the big NG independents. The CEO of CHP (as do all the other CEO's) has one primary responsibility: maximize shareholder value. Difficult to convince folks to bid up the price of CHP shares by telling them there are clear limits to groeth potential.