Chesapeake Energy, Fracking Pioneer, Bet on Oil. Then Prices Plunged
January 01 2019 - 12:03PM
Dow Jones News
By Rebecca Elliott
DOUGLAS, Wyo. -- Chesapeake Energy Corp., best known for its
trailblazing pursuit of natural gas from shale formations, is
making a big bet on the oil below the rolling grasslands of eastern
Wyoming.
Its timing doesn't look great. U.S. oil prices have fallen more
than 40% since early October to close at $45.41 a barrel on Monday,
straining the finances of the debt-laden company co-founded by
Aubrey McClendon, the late wildcatter. It is a rough time to be
planning new shale wells anywhere, but especially in Wyoming's
Powder River Basin, an expensive and geologically complex
place.
"It seems like every time we make a big strategic step forward
we get snake-bitten," said Chesapeake board member Archie Dunham,
previously chief executive of Conoco Inc. Mr. Dunham has purchased
more than $9 million worth of Chesapeake stock in recent weeks.
Chesapeake's challenges exemplify how oil's recent price drop is
jeopardizing the recoveries of shale drillers still trying to
regain their strength after the last crash in prices in 2014 and
2015. The company's share price has fallen nearly 56% since early
October, compared with a 40% drop in a broad index of U.S.
producers.
Chief Executive Doug Lawler said lower oil prices stress a
company like Chesapeake, which reported $9.4 billion in long-term
debt at the end of the third quarter. The Oklahoma City-based
company plans to dedicate at least 80% of 2019 capital expenditures
to oil production because it sees crude as the key to a more
profitable future, he said.
"Quite simply, the margins are far superior to gas," Mr. Lawler
said. "We have to run the company regardless of what price is."
Chesapeake is moving to oil relatively late compared with many
of its peers, which anticipated that a glut of natural gas in the
U.S. would depress prices and make drilling for it less lucrative.
In addition to stepping up oil drilling in Wyoming over the past
two years, Chesapeake announced in October a deal to acquire
oil-focused Wildhorse Resource Development Corp. for $4 billion,
its first large acquisition in more than a decade.
Crude was trading at about $67 a barrel when the companies
announced the deal, which has yet to close. It would allow
Chesapeake to increase its oil output while reducing its financial
leverage. Although Wildhorse had $1.1 billion in long-term debt at
the end of the third quarter, the company has a lower debt ratio
than Chesapeake.
Timing the market is notoriously difficult and getting more so,
said Robert McNally, president of Rapidan Energy Group, an energy
consultancy. The annual maximum and minimum oil price has differed
by an average 36% since 2008, according to Rapidan, compared with
24% from 1973 to 2007.
"You're starting to see massive price swings caused by unusual
triggers, " Mr.McNally said. "This is making it even harder for
deal makers to price deals."
Chesapeake's oil and gas output fell more than 20% from its peak
in 2014 to the end of 2017, the result of reining in spending and
selling oil and gas interests as it moved to reduce debt.
Meanwhile, the company has spent more than it has taken in every
year starting with 2010, according to FactSet.
To improve cash flow, Chesapeake needs to produce more. The
company's operations in Wyoming, where it added a fifth drilling
rig last year, will be a test. In early December, Chesapeake was
threading a drill bit through sandstone more than 2 miles
underground. Each well takes about three weeks to drill.
Wyoming's Powder River Basin is composed of layers of
oil-bearing rock, giving companies multiple opportunities to
exploit the resource from the same acreage. That has attracted
producers including EOG Resources Inc., which operated an average
of two drilling rigs in the basin in 2018.
The basin covers a relatively small area with heterogeneous
rocks that are frequently laced with faults, making drilling more
expensive. It costs Chesapeake roughly $8 million to drill and
hydraulically fracture each of its wells in Wyoming, compared with
about $6 million in the Eagle Ford shale of South Texas. The extra
expense is worth it, executives said, because the wells are more
prolific.
"I think we can unlock those plays that people may not be paying
attention to, and this is one of them," said Frank Patterson,
Chesapeake's executive vice president for exploration and
production.
Even so, lower oil prices crimp profits. Chesapeake says it has
fine-tuned its approach such that its Wyoming wells can generate
returns at $25 to $35 oil, well below the basin-wide average of
$47, according to consulting firm RS Energy Group.
However, those so-called break-even prices don't take into
account full corporate overhead or land costs. The average
all-inclusive break-even in the Powder River Basin is $61,
according to RS Energy.
Chesapeake hasn't released its 2019 spending plan, but Mr.
Lawler said with oil below $50, it would consider adjusting its
capital program.
"It's a wait-and-see moment for not just Chesapeake, but a lot
of oil-and-gas companies," said J. Mike Stice, a former Chesapeake
executive who now serves as a dean at the University of
Oklahoma.
Write to Rebecca Elliott at rebecca.elliott@wsj.com
(END) Dow Jones Newswires
January 01, 2019 11:48 ET (16:48 GMT)
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