Wednesday, March 26, 2008

Peaking At Chesapeake

According to Chesapeake's March 2008 Investor Presentation (click sample slide above) the Barnett Shale is the nations best resource play and is increasing production and reserves rapidly as Chesapeake ramps up drilling to prove reserves. But there is more to the story .... Could Chesapeake's interest be waning? What happens when another cute girl walks by and looks interested?

According to Chesapeake's CEO, Aubrey K. McClendon, during his 3/25/08 conference call, the Barnett Shale has the highest rate of return on capital investment of any of Chesapeake's three major drilling areas. To make sure that they hold their leases, which are becoming much more expensive to acquire due to increased competition, Chesapeake is increasing their rig count in the Fort Worth area from 40 to 45 rigs.

However, Chesapeake's CEO went on to announce (quite reluctantly due to the desire to maintain competitive security) a new shale discovery in Louisiana that he believes is even more important than the Barnett Shale. Mr. McClendon indicated that the Haynesville Shale in northern Louisiana is ... "the most important operational announcement in Chesapeake's 19 year history." With 200,000 acres leased and a goal of 500,000 acres in the next few years, this field could increase net-to-Chesapeake potential reserves by up to 20 TCFE ($200 Billion at $10/MCFE). This compares to 260,000 net acres in the Barnett Shale with about 8 TCFE in reserves. Further detail about the Chesapeake announcement is also available in the Fort Worth Star Telegram article by Maria Perotin entitled "Chesapeake discovers Louisiana gas field."

Details of the discovery were limited during the call since they are competitive sensitive. However, drilling and development net costs for the new area should be similar to the $2/MCFE that is typical of the Barnett and other prime areas being developed by Chesapeake.

In a related article the magnitude of these estimates from Chesapeake were corroborated by Cubic Energy, a competitor in the Haynesville area. In this article Cubic claims their reservoir engineering estimates indicate gas reserves for the Bossier/Haynesville shale ranges from 217 to 245 BCF/section. That is about 40% greater than the reserve estimated by XTO (160 BCF/section) for the Barnett shale of Tarrant County.

So what does this mean for the mineral owners in the Barnett Shale? Could this mean that Chesapeake will be distracted by a new opportunity? Will already strained drilling programs and dollars be diverted to other opportunities? Will this further delay the required intensive development of Fort Worth minerals (except the minimum required to hold them by production)?

Such distractions could significantly limit the royalty stream paid on leases in the Barnett Shale for many years. So if you have leased a quarter acre to Chesapeake, you might well forget about receiving any royalties above $500 per year for many years to come. Chesapeake may be "too busy" if their interest in the Barnett Shale has peaked and they are "moving on" to prettier plays where they can focus on higher returns for shareholders.