Chesapeake Reducing Per-Unit Production Costs

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On Feb. 21, Chesapeake Energy (NYSE: CHK) surprised Wall Street by beating estimates on both top and bottom lines. The company’s latest earnings call was focused on increasing profitability by shifting production from gas to liquids to boost revenue, and becoming more efficient to lower costs. To meet its efficiency goals the company intends to reduce capex and lower per-unit costs by transitioning to pad drilling.

Transition to pad drilling

Pad drilling might sound like a fun game for tablets, but it actually refers to a technique that allows rig operators to drill several wells at a time. After drilling one well rigs typically need to be taken apart, loaded on a truck, transported to the next location, then reassembled. Pad drilling significantly boosts a crew’s efficiency because the rig is simply nudged a few yards along the pad where it begins a new well.

On the surface, there may appear to be a single well, but underground there can be as many as ten horizontal wells lying parallel to each other. During the life of the well, costs associated with capturing and transporting are also reduced. During the Q4 2012 earnings call, Chesapeake COO Steve Dixon claimed that the company is targeting capital efficiency gains of at least 15-20% as they transition to pad drilling techniques.

Getting more and spending less

During the fourth quarter of 2012 Chesapeake connected 98 wells in the Eagle Ford Shale. The company expects to continue at the same rate of about one hundred wells per quarter in that area, but intends to reduce the overall rig count by 14. During Q4 2012 the average time between starting wells -- spud-to-spud time -- was 18 days. During the same period in 2011, that time was 26 days. That’s about 30% faster, and not surprisingly about 30% less expensive.

So far this year spud cycle times continue to decrease. Recently, in the Eagle Ford Shale, a Chesapeake crew finished a well in just 8 days. Looking ahead to 2014, the company expects to increase the percentage of wells drilled on existing pads by more than threefold compared to its estimates for 2013.

Chesapeake is not the only company enjoying pad drilling savings

Also operating in the Eagle Ford Shale is Pioneer Natural Resources (NYSE: PXD). During its Q4 2012 earnings call, the Irving, Texas based independent producer noted it expects to drill about 130 new wells in the Eagle Ford Shale this year. By employing pad drilling techniques it expects to save between $600,000 and $700,000 per well, a savings of more than 10%.

Independent oil and gas producer Devon Energy (NYSE: DVN) has also been enjoying increased efficiency by using pad drilling techniques. During its Q4 conference call the company reported a spud cycle time reduction of more than 20% year-on-year in the Cana Woodford Shale.

Will increased efficiency be enough to reduce Chesapeake’s enormous debt?

The looming pile of debt that Chesapeake has hanging over its head is enough to give me nightmares. Long-term debt is still more than $12 billion. Further worrying me is CFO Domenic Dell’Osso’s admission that the gap between total spending and expected cash flow for 2013 is about $4 billion. Dell’Osso insisted that the company was focused on reducing its debt, but didn’t give any details about upcoming asset sales.

Activist investor, Carl Icahn, has a great deal of confidence in Chesapeake’s ability to push through this difficult time and come out on top in 2014. Back in November of last year he upped his stake in the company to nearly 9%. Not content to watch from the sidelines, he used his leverage to rearrange the board. Knowing that Icahn is pulling the strings is a big relief, but as a defensive value investor, I am not about to get involved with the company until I’m certain its liquidity problems are completely solved.


crenauer has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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