Chesapeake shuns gas, shrinks rig count

Chesapeake Energy Corp., which calls itself America’s Champion of Natural Gas, said Tuesday it is basically giving up on gas drilling this year, adding to an industrywide retreat from what has been deemed the fuel of the future.

The nation’s second-largest natural gas producer after Exxon Mobil Corp. said that as part of a major contraction in its operations it has cut its plan for new gas exploration by 83 percent.

Chesapeake previously had planned to operate 47 gas rigs in 2012, but now hopes to cut that rig count to eight by the end of the year, executives said during a conference call with analysts on Tuesday to discuss the company’s second-quarter earnings.

That shift by the most prominent proponent of natural gas came as fossil fuel producers across the spectrum are shying away from gas drilling, even though they have invested billions of dollars in its promise as a major energy resource for the future.

The problem is price.

“Clearly you’re going to have to have higher prices than $3 in 2013 to incentivize producers to come back,” Chesapeake CEO Aubrey McClendon said. “For us, it’s got to be a pretty healthy price to pry our rigs away from our liquids-focused areas.”

The Oklahoma City-based company is in the midst of a major transformation as it attempts to rebound from betting as much as 90 percent of its spending on natural gas in recent years. When gas prices fell, Chesapeake developed a large cash shortfall and its debt ballooned to $14.3 billion.

While Chesapeake continues to be a major gas producer, it is putting an emphasis on more lucrative oil drilling while also trimming costs. To that end, the company will halve its overall plans for active drilling rigs, McClendon said.

“We were planning to run 200 rigs at the start of 2013 and now we’re planning to run 100,” he said of the company’s total number of rigs.

‘Very different strategy’

Chesapeake expects to cut its drilling budget by $750 million next year because of the decrease in rigs, but it also hopes to increase production of oil and other hydrocarbons, McClendon said.

“As we pull in our horns and focus and concentrate our drilling in areas that are going to generate the highest returns, it’s a very different strategy than what we’ve used in the last few years,” he said.

That strategic change was not a surprise, although the scale of the company’s cut in gas-oriented rigs was more aggressive than expected, said Neal Dingmann, an analyst with SunTrust Robinson-Humphrey.

That doesn’t mean Chesapeake will be dethroned as one of the country’s top producers. It expects to produce 1.1 trillion cubic feet of natural gas in 2012, nearly a fourth of nationwide residential demand for gas, based on government demand projections.

“They’re probably still going to be No. 1 or 2 no matter what they do, even if they fall off, because no one’s trying to grow natural gas production,” said Jason Wangler, an analyst for Wunderlich Securities in Houston.

‘North of $5’

Asked at what price natural gas would become attractive to drill again, McClendon said it would depend on the returns of gas drilling when compared with the potential from establishing new oil and natural gas liquids wells. Natural gas liquids include such fuels and manufacturing feedstocks as propane, ethane and butane.

“I think the industry has said that the number’s probably north of $5 before gas plays generate the same kind of returns that you can get from oil around $90,” McClendon said.

Natural gas closed Tuesday at $2.964 per million British thermal units on the New York Mercantile Exchange, up 5.6 cents. U.S. benchmark crude closed up $1.47 at $93.67 a barrel.

McClendon added that Chesapeake would remain poised for a return to more extensive gas drilling.

“Gas prices have a way to go to catch up to levels that equal the returns we get from our liquids-focused plays and we’ll just wait for it to play out,” he said. “We’ve got an enormous backlog of gas drilling opportunities and we’ll take advantage of those when the gas market tells us to do so.”

Analysts and investors were encouraged by Chesapeake’s efforts to cut its spending on rigs and reduce its debt.

Shares in Chesapeake rose $1.67 on Tuesday, closing at $19.37 on the New York Stock Exchange.

Its shares are down almost 40 percent from a year ago, however, amid concerns about its cash flow, debt and company governance.