• Net Income Available to Common Shareholders Reaches $523 Million on Revenue of $1.9 Billion and Production of 147 Bcfe; Net Income of $1.13 per Fully Diluted Common Share Increases 163% Over the 2005 Third Quarter
• Proved Reserves Reach Record Level of 8.4 Tcfe; Company Delivers Year To Date Reserve Replacement Rate of 314% From 1.34 Tcfe of Additions at a Drilling and Acquisition Cost of $1.89 per Mcfe
• Recent Acquisitions Add 490 Bcfe of Proved and Unproved Reserves in South Texas, Fort Worth Barnett Shale and Northwest Oklahoma Plays; Company Expands West Texas Delaware Shale Position to 700,000 Net Acres and Increases Fayetteville Core Position to 340,000 Net Acres; Company Enters Shale Plays in Alabama, Kentucky and Illinois
• Company Updates Detailed Review of its 16.4 Tcfe of Risked Unproved Reserves Located on its 10.5 Million Net Acres of U.S. Onshore Leasehold and Significantly Increases its Production Growth Forecasts for 2007 and 2008
Chesapeake Energy Corporation has reported strong financial and operating results for the third quarter of 2006. For the quarter, Chesapeake generated net income available to common shareholders of $523 million ($1.13 per fully diluted common share), operating cash flow of $989 million (defined as cash flow from operating activities before changes in assets and liabilities) and ebitda of $1.329 billion (defined as net income before income taxes, interest expense, and depreciation, depletion and amortization expense) on revenue of $1.929 billion and production of 147 billion cubic feet of natural gas equivalent (bcfe). For the quarter, ebitda and net income per fully diluted common share increased 129% and 163%, respectively, over the 2005 third quarter.
The company's 2006 third quarter net income available to common shareholders and ebitda include an after-tax unrealized mark-to-market gain of $150 million resulting from the company's oil and natural gas and interest rate hedging programs that is typically not included in published estimates of the company's financial results by certain securities analysts. Excluding this item, Chesapeake's net income to common shareholders in the 2006 third quarter would have been $373 million ($0.83 per fully diluted common share) and ebitda would have been $1.091 billion. The foregoing item does not affect the calculation of operating cash flow. For the quarter, adjusted ebitda and adjusted net income per fully diluted common share increased 59% and 28%, respectively, over the 2005 third quarter.
Production
Oil and Natural Gas Production Sets Record for 21st Consecutive Quarter; 2006 Third Quarter Average Daily Production Increases 22% Over the 2005 Third Quarter and 2% Over the 2006 Second Quarter
Daily production for the 2006 third quarter averaged 1.597 bcfe, an increase of 289 million cubic feet of natural gas equivalent (mmcfe), or 22%, over the 1.308 bcfe of daily production in the 2005 third quarter and an increase of 29 mmcfe, or 2%, over the 1.568 bcfe produced per day in the 2006 second quarter. Chesapeake's production in the 2006 third quarter did not meet the company's expectations primarily because of delays in Fort Worth Barnett Shale well completions caused by a new drilling program that favors utilizing multi-well drilling pads over single well drilling locations. The company believes this new approach will lead to more efficient field development and may ultimately result in greater per well reserve recoveries. However, it also creates a large backlog of uncompleted wells (currently approximately 30 wells) as all drilling from a pad must be completed before completion and production operations may commence.
The company's current rate of production is approximately 1.66 bcfe per day, which includes approximately 0.1 bcfe per day of previously curtailed production that is now back on line. Based on the company's projected drilling levels and anticipated results, Chesapeake is forecasting production growth of 23-24% for 2006 and is raising its production growth forecasts in 2007 and 2008 to ranges of 14-18% and 10-14%, from previous forecasts of 10-12% and 5-7%, respectively.
Chesapeake's 2006 third quarter production of 146.9 bcfe was comprised of 133.8 billion cubic feet of natural gas (bcf) (91% on a natural gas equivalent basis) and 2.18 million barrels of oil and natural gas liquids (mmbbls) (9% on a natural gas equivalent basis). Chesapeake's average daily production for the quarter of 1.597 bcfe consisted of 1.455 bcf of natural gas and 23,674 barrels (bbls) of oil. The 2006 third quarter was Chesapeake's 21st consecutive quarter of sequential U.S. production growth. Over these 21 quarters, Chesapeake's U.S. production has increased 308%, for an average compound quarterly growth rate of 6.9% and an average compound annual growth rate of 30.5%.
Reserves
Oil and Natural Gas Proved Reserves Reach Record Level of 8.4 Tcfe; During the First Three Quarters of 2006, Drilling and Acquisition Costs Averaged $1.89 per Mcfe as Company Added 1.34 Tcfe for a Reserve Replacement Rate of 314%
Chesapeake began 2006 with estimated proved reserves of 7.521 trillion cubic feet of natural gas equivalent (tcfe) and ended the third quarter with 8.433 tcfe, an increase of 912 bcfe, or 12%. During the first three quarters of 2006, Chesapeake replaced its 426 bcfe of production with an estimated 1.339 tcfe of new proved reserves, for a reserve replacement rate of 314%. Reserve replacement through the drillbit was 825 bcfe, or 194% of production (including 541 bcfe of positive performance revisions and 387 bcfe of downward revisions resulting from natural gas price declines between December 31, 2005 and September 30, 2006) and 62% of the total increase. Reserve replacement through the acquisition of proved reserves was 514 bcfe, or 120% of production and 38% of the total increase.
On a per thousand cubic feet of natural gas equivalent (mcfe) basis, the company's total drilling and acquisition costs were $1.89 (excluding costs of $2.6 billion for leasehold and unproved properties acquired during the period and $181 million relating primarily to tax basis step-up and asset retirement obligations, as well as downward revisions of proved reserves from lower natural gas prices). Excluding these items described above, Chesapeake's exploration and development costs through the drillbit were $1.76 per mcfe during the first three quarters of 2006 while reserve replacement costs through acquisitions of proved reserves were $1.99 per mcfe. A complete reconciliation of finding and acquisition costs and a roll-forward of proved reserves are presented on page 19 of this release.
During the first three quarters of 2006, Chesapeake continued the industry's most active drilling program and drilled 1,024 gross (845 net) operated wells and participated in another 1,154 gross (141 net) wells operated by other companies. The company's drilling success rate was 98% for company-operated and non-operated wells. Also during the first three quarters of 2006, Chesapeake invested $1.769 billion in operated wells (using an average of 89 operated rigs), $363 million in non-operated wells (using an average of 74 non-operated rigs), $456 million to acquire new leasehold (exclusive of $2.1 billion in unproved leasehold acquired through acquisitions) and $102 million to acquire 3-D seismic data.
As of September 30, 2006, the estimated future net cash flows of Chesapeake's proved reserves, before income taxes and discounted at 10% (PV-10), were $9.7 billion using field differential adjusted prices of $58.12 per barrel of oil (bbl) (based on a NYMEX quarter-end price of $62.82 per bbl) and $3.96 per thousand cubic feet of natural gas (mcf) (based on a NYMEX quarter-end price of $4.18 per mcf). By comparison, as of June 30, 2006 the PV-10 of Chesapeake's proved reserves was $15.0 billion using field differential adjusted prices of $69.10 per bbl (based on a NYMEX quarter-end price of $73.86 per bbl) and $5.72 per mcf (based on a NYMEX quarter-end price of $6.09 per mcf). In addition to the PV-10 value of its proved reserves, the net book value of the company's other assets (including drilling rigs, land and buildings, investments in securities, long-term derivative instruments and other non-current assets) was $2.8 billion as of September 30, 2006 and $1.8 billion as of June 30, 2006.
Chesapeake's September 30, 2006 PV-10 changes by approximately $329 million for every $0.10 per mcf change in natural gas prices and approximately $50 million for every $1.00 per bbl change in oil prices. The company calculates the standardized measure of future net cash flows in accordance with SFAS 69 only at year-end because applicable income tax information on properties, including recently acquired oil and natural gas interests, is not readily available at other times during the year. As a result, the company is not able to reconcile the interim period-end values to the standardized measure at such dates. The only difference between the two measures is that PV-10 is calculated before considering the impact of future income tax expenses, while the standardized measure includes such effects.
Company Announces Approximately $660 Million of Acquisitions in South Texas, Fort Worth Barnett Shale and Northwest Oklahoma Plays; Acquires Approximately 490 Bcfe of Proved and Unproved Reserves
Chesapeake has acquired or has agreed to acquire from four private companies natural gas assets located in its South Texas, Fort Worth Barnett Shale and Northwest Oklahoma plays for an aggregate purchase price of approximately $660 million in cash. Through these transactions, Chesapeake is acquiring an internally estimated 490 bcfe of reserves, which are comprised of 160 bcfe of proved reserves and 330 bcfe of unproved reserves.
After allocating $324 million of the $660 million purchase price to unproved reserves and $45 million to midstream assets, Chesapeake's acquisition cost for the 160 bcfe of internally estimated proved reserves will be approximately $1.82 per mcfe. Based on the company's projected development plan, which includes $750 million of anticipated future drilling and development costs, Chesapeake estimates that its all-in cost of acquiring and developing the 490 bcfe of proved and unproved reserves will be approximately $2.80 per mcfe. As a percentage of the combined purchase price, the acquisitions are located 47% in South Texas, 45% in the Fort Worth Barnett Shale and 8% in Northwest Oklahoma.
Chesapeake Increases Cost Inflation Hedges through Additional Oilfield Service Investments
To further hedge its exposure to oilfield service costs and achieve greater operational efficiencies, Chesapeake recently invested approximately $250 million to acquire a 19.9% interest in a rapidly growing privately-held provider of well stimulation and high pressure pumping services, with operations currently focused in Texas (principally in the Fort Worth Barnett Shale) and the Rocky Mountains. This service company also has expansion efforts underway in other key regions in which Chesapeake operates.
This investment complements Chesapeake's direct and indirect drilling rig investments that have served as an effective hedge to higher service costs and have also provided competitive advantages in making acquisitions and in developing the company's own leasehold on a more timely and efficient basis. To date, Chesapeake has invested approximately $254 million to build or acquire 42 drilling rigs and is building 22 additional rigs. During the 2006 third quarter, the company entered into a sale/leaseback transaction to monetize its investment in 18 rigs in exchange for cash proceeds of $188 million. These rigs are under lease to Chesapeake through 2014, at which time the company has the option to reacquire them.
In total, the company's drilling rig fleet should reach 82 rigs by mid-year 2007, which would rank Chesapeake as the sixth largest drilling rig contractor in the U.S. Additionally, the company has a $69 million investment in two private drilling rig contractors, DHS Drilling Company and Mountain Drilling Company, in which Chesapeake's equity ownership is approximately 45% and 49%, respectively. DHS owns 16 rigs and Mountain is operating two rigs and has another eight rigs under construction or on order for delivery in 2006 and 2007.
Chesapeake Significantly Expands Acreage Position in the Fort Worth Barnett Shale Play in Johnson, Tarrant and Western Dallas Counties
During the third quarter, Chesapeake significantly expanded its holdings in the Fort Worth Barnett Shale play through acquisitions totaling approximately 55,400 net acres primarily in Johnson, Tarrant and western Dallas counties. These transactions included 26,500 net acres acquired from Four Sevens Oil Co. Ltd. and Sinclair Oil Corporation, 16,600 net acres acquired from the Dallas/Fort Worth International Airport Board and the cities of Dallas and Fort Worth and 12,300 net acres acquired in two transactions with Dale Resources, LLC, et al. In addition, Chesapeake has continued its ongoing "off-the-ground" leasing efforts in the play through numerous transactions with various municipalities, school districts and industrial and commercial property owners.
Chesapeake's Tier 1 leasehold position now totals approximately 150,000 net acres and is concentrated in the "sweet spot" of Johnson, Tarrant and western Dallas counties. On this acreage, the company believes it has the ability to drill approximately 2,100 additional net horizontal wells with lateral lengths of approximately 3,000 feet on 500 foot average well spacing. The company's expected results for wells drilled on its Tier 1 acreage are $2.7 million to develop 2.45 gross bcfe (1.8 net bcfe after royalties and other burdens). From its Fort Worth Barnett Shale acreage position, Chesapeake is now producing approximately 240 gross mmcfe per day (168 net mmcfe) from 347 gross operated wells, of which Chesapeake has drilled 213 and has acquired 134.
Chesapeake is currently utilizing 17 operated drilling rigs to develop its Fort Worth Barnett Shale acreage and by the end of 2006 should have approximately 24 operated rigs drilling in the play. For 2007 and 2008, Chesapeake is budgeting an average operated drilling rig count of 30-35 rigs in the play. From a program of this scale, the company believes that it should be able to drill 450-500 wells per year and should be able to replace 125-150% of the company's total production from its Fort Worth Barnett Shale drilling program alone. This would leave approximately 100 additional operated rigs to deliver further growth in production and proved reserves elsewhere.
Looking forward, Chesapeake expects to continue acquiring more acreage in the Forth Worth Barnett Shale, primarily in Johnson, Tarrant and western Dallas counties, with a special focus on the urban areas of Tarrant and western Dallas counties. In these areas, Chesapeake has acquired more than 100 urban drillsite pads from which it can drill multiple wells, in some cases up to 12 wells per pad. The ownership of these urban pads and its ongoing land services agreement with Dale Resources provide the company with distinctive advantages in acquiring additional leases in "halo" areas surrounding these pads.
Chesapeake Expands Acreage Positions in the Fayetteville Shale to 1,040,000 Net Acres, West Texas Delaware Shale to 700,000 Net Acres and Southeast Oklahoma Woodford Shale to 100,000 Net Acres; Company Enters Alabama Shale Plays with 110,000 Net Acres and New Albany Thermogenic Shale Play in Illinois and Kentucky with 220,000 Net Acres
Chesapeake has previously stated its goal of establishing a top three presence in every major shale play east of the Rockies. The company believes it has largely accomplished this goal through a focused series of innovative transactions. For example, in the Fayetteville Shale play in Arkansas, Chesapeake now owns approximately 1,040,000 net acres, of which approximately 340,000 net acres are in the highly prospective core area in the central and western portions of the play. The company has drilled 12 horizontal wells to date, is in the process of acquiring several large 3-D seismic surveys and is increasing its operated rig count from two to seven rigs in the play by year-end 2006.
In the Barnett and Woodford Shale plays of the Delaware Basin in far West Texas, the company has entered into four joint venture agreements with one large public independent and three private companies to pursue the development of these shales and other conventional and unconventional plays. In Culberson, Reeves, Pecos and Brewster counties, Chesapeake now owns the right to develop approximately 700,000 net acres (1.3 million gross acres), the largest such leasehold position in the Delaware Shale play. The company currently has two operated rigs drilling on this acreage and plans to further explore the area in 2007 and 2008 with aggressive 3-D seismic and exploratory drilling programs.
Located in the Arkoma Basin of southeastern Oklahoma, the Woodford Shale is a play of increasing importance to Chesapeake. The company recently completed two transactions that increased its leasehold inventory in the play to approximately 100,000 net acres. In 2007, the company plans to shoot two 3-D seismic surveys and currently has one operated rig drilling in the play. To date, Chesapeake has drilled one successful vertical well and one successful horizontal well in the Woodford Shale play.
Earlier this month, Chesapeake announced that it has entered into a 50/50 statewide area of mutual interest covering all of Alabama with Energen Resources Corporation of Birmingham, Alabama. Chesapeake acquired 100,000 net acres from Energen to augment the approximate 10,000 net acres Chesapeake had previously acquired in Alabama. The two companies plan to initiate 3-D seismic and exploratory drilling programs in 2007.
Chesapeake's Leasehold and 3-D Seismic Inventories Now Total 10.5 Million Net Acres and 14.7 Million Acres; Risked Unproved Reserves in the Company's Inventory Now Reach 16.4 Tcfe, Bringing Total Reserve Base to 24.8 Tcfe
Since 2000, Chesapeake has invested $5.7 billion in new leasehold and 3-D seismic acquisitions and now owns what it believes to be the largest inventories of onshore leasehold (10.5 million net acres) and 3-D seismic (14.7 million acres) in the U.S. On this leasehold, the company has an estimated 25,000 net drilling locations, representing an approximate 10-year inventory of drilling projects, on which it believes it can develop approximately 3.2 tcfe of proved undeveloped reserves and approximately 16.4 tcfe of risked unproved reserves (68 tcfe of unrisked unproved reserves). Chesapeake's 8.4 tcfe of proved reserves and its risked unproved reserves together total approximately 24.8 tcfe.
To develop these assets more aggressively, Chesapeake has continued to significantly strengthen its technical capabilities by increasing its land, geoscience and engineering staff to approximately 800 employees. Today, the company has approximately 4,600 employees, of which approximately 65% work in the company's E&P operations and approximately 35% work in the company's oilfield service operations.
Management Comments
Aubrey K. McClendon, Chesapeake's Chief Executive Officer, commented, "We are pleased to report outstanding financial and operational results for the 2006 third quarter. The company delivered attractive production and reserve growth and generated impressive profit margins that were enhanced by the company's timely and well-executed hedging strategy. Our focused business strategy, value-added growth, tremendous inventory of undrilled locations and valuable hedge positions clearly differentiate Chesapeake in the industry.
"In light of continued strong returns available through the drillbit on our extensive prospect inventory, we continue to increase our industry-leading U.S. drilling activity to accelerate development of our substantial proved undeveloped and unproved reserve base. We currently have 120 operated rigs working, up from an average of 73 operated rigs in 2005 and an average of 89 operated rigs to date in 2006. We anticipate increasing our drilling activity to approximately 133 operated rigs by year-end 2006 and up to 150 operated rigs in 2007.
"We are clearly transitioning from the past six years of resource inventory capture to many more years of resource inventory conversion. We believe the result of this transition will be significant increases in proved reserves and production levels in 2007 and beyond. This shift in focus is best evidenced by the increases in future production growth rate ranges that we are announcing today, 14-18% for 2007 and 10-14% for 2008.
"Our business strategy continues to feature delivering growth through a balance of acquisitions and organic drilling, focusing on clean-burning, domestically-produced natural gas to take advantage of strong long-term natural gas supply and demand fundamentals, building dominant regional scale to achieve low operating costs and high returns on capital and mitigating financial and operational risks through opportunistic hedging. We believe Chesapeake's management team can continue the successful execution of the company's distinctive business strategy and continue to deliver significant value to the company's investors for years to come."
