Chesapeake Energy Sends Market Signal

By Eric Fox | January 22, 2012 AAA

Chesapeake Energy (NYSE:CHK) announced major cuts in the company's dry gas drilling program in 2012 as this large exploration and production company looks to help balance supply and demand in the natural gas market. The company will also shut in a significant amount of its current dry gas production to help reduce supply.

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Natural Gas Prices
Natural gas prices have fallen to $2.32 per thousand cubic feet, the lowest levels in a decade due to excess supply generated from domestic shale and unconventional plays, along with sluggish demand for the commodity.

Chesapeake Energy Throws Down the Gauntlet
Chesapeake Energy announced a number of actions to help improve the fundamentals in the natural gas market. It will reduce the number of rigs that it has operating in dry gas plays in the United States, implementing a 50% cut by the second quarter of 2012. (To know more about oil and gas, read Oil And Gas Industry Primer.)

This would reduce the rig count in these plays from the current level of 47, down to 24. These cuts are not the first for the company as it operated an average of 75 rigs in 2011. The 50% reduction will be instituted equally across the its properties in the Haynesville, Barnett and Marcellus Shales.

Chesapeake's total expenditures for dry gas development will total only $900 million in 2012, down from $3.1 billion last year, and will be the lowest level of natural gas spending for the company since 2005.

It also plans to shut in 500 million cubic feet (Mcf) per day of the company's operated natural gas production. This represents 8% of its current gross natural gas production of 6.3 billion cubic feet (Bcf). The company has a contingency plan to double the amount of shut in production to one Bcf per day if needed. It's not clear whether these actions were taken only to help balance the market, or also to cut production from wells that are not profitable to operate at the current low prices for natural gas.

Will It Work?
Chesapeake's actions appear to have had some short-term impact as natural gas futures increased in the wake of the company's announcement. One issue is whether other operators will mimic the market signal from Chesapeake and cut production as well.

Range Resources (NYSE:RRC), another major natural gas producer, announced its 2011 year end reserve report on the same day as Chesapeake Energy's announcement, and made no mention of any drilling or production cuts.

The market will be watching other large natural gas producers during the upcoming earnings season to see if any operators take similar action. The five largest natural gas producers outside of Chesapeake Energy include:

2011 Third Quarter Production

Companies Bcf Per Day
Exxon Mobil (NYSE:XOM) 3.9
Anadarko Petroleum (NYSE:APC) 2.2
Devon Energy (NYSE:DVN) 2
EnCana (NYSE:ECA) 1.9
BP (NYSE:BP) 1.8

(Source: Natural Gas Supply Association)

The Bottom Line
Chesapeake Energy flexed its market leading muscles in the domestic natural gas market with some dramatic cuts in natural gas drilling and production. This action may be for naught unless other producers match this company's bold move. (For additional reading, check out A Guide To Investing In Oil Markets.)

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At the time of writing, Eric Fox did not own shares in any of the companies mentioned in this article.

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