Chesapeake Stockpiles DUCs as Doubts Creep in Over Southwestern Deal

Like its peers, Chesapeake Energy is maneuvering through a weak natural gas market by curtailing production until supply and demand balances out.

The E&P is also navigating an intensified Federal Trade Commission (FTC) review that has introduced doubts into whether Chesapeake’s $7.4 billion merger with Southwestern Energy will close or belly flop. 

“There is also rising concern among investors that the FTC will prevent the merger from consummating which creates an overhang,” said Gabriele Sorbara, managing director at Siebert Williams Shank & Co. in a May 1 commentary. “We maintain our Hold rating on the merger uncertainties and less attractive pro forma valuation relative to peers.” 

As federal scrutiny of the deal continues, Chesapeake is building for the future: a stockpile of DUCs that it can quickly turn to sales when prices recover.

“No shifts on the overall activity plan with management reiterating status quo is to build DUCs through 2024 in what we continue to see as prudent decision making that will position CHK [Chesapeake Energy] well for a recovery into 2025,” analyst Matt Portillo with Tudor, Pickering, Holt & Co. wrote in a May 1 commentary.

Chesapeake added 24 DUCs in the first quarter. At the end of the quarter, the company had 50 DUCs—twice the normal average, according to its earnings report.

Natural gas prices are hitting record lows due to associated gas from oil production, high storage inventory and warm winter weather. Producers are having to slash production to keep up.

For the Oklahoma City-based E&P, the plan is to continue what it had already announced at the end of 2023—deferring completions and new well turn in lines in favor of building short-cycle production capacity to be activated in the future.

Chesapeake deferred 22 turn-in-line wells in the quarter and curtailed 200 MMcf/d of its base production. The company plans to curtail approximately 400 MMcf/d in the second quarter, according to its quarterly earnings release.

Volumes will flow back in subsequent quarters in the second half of 2024 following the second quarter’s curtailments, COO Josh Viets said.

“The market is pretty clearly oversupplied and we don't want to bring on wells in an environment where the initial production of these wells, the significant part of the return, comes to market in an oversupplied market and receives a lower than breakeven price,” said Nick Dell’Osso, president and CEO.

RELATED

EIA: Permian, Bakken Associated Gas Growth Pressures NatGas Producers

CNX, Appalachia Peers Defer Completions as NatGas Prices Languish

While the natural gas market is less than favorable at the moment, Chesapeake anticipates natural gas demand to grow significantly from LNG exports, power generation and industrial activity, Dell’Osso said during the first-quarter earnings call.

In February, the company signed LNG sale and purchase agreements for approximately 0.5 million tonnes per annum (mtpa). Offtake agreements were signed with Delfin LNG, Gunvor and Vitol.

Chesapeake’s current plan—with its low-cost structure and deep inventory—will allow the company to quickly meet a rebound in demand growth, Dell’Osso said.

Merger doubts

Dell’Osso said he still anticipates closing a merger with Southwestern in the second-half 2024.

“We did feel like the merger with Southwestern allowed us to advance on those fronts and have real synergies, real industrial logic that helps to improve our ability to meet those goals over time,” Dell’Osso said.

But the merger itself has introduced uncertainty since Southwestern is no longer providing guidance, muddying the pro forma outlook should the companies successfully combine, Sorbara said.

The FTC has already delayed the merger.

In early April, the FTC requested more information on the pending merger between the top natural gas producers in the Appalachia and Haynesville, that if combined, would create the largest natural gas producer in the country with over 5,000 pro forma gross locations across the two basins.

Chesapeake and Southwestern are among several companies facing FTC review. Second requests were also filed for the mergers of Chevron Corp.  and Hess Corp. On May 2, the FTC took a heavy handed approach to Exxon Mobil’s acquisition of Pioneer Natural Resources, forcing the companies to abandon plans to add Pioneer Chairman Scott Sheffield to Exxon’s board. Most recently, on April 30, Diamondback Energy’s $26 billion merger with Endeavor Energy Resources was delayed by an FTC request for more information.

In response to an analyst question about the pending merger with Southwestern, Dell’Osso said Chesapeake is eager to work with the FTC to answer the commission’s questions.

“We feel good about the underlying merits of the transaction and look forward to getting through this process and getting it closed, but really hard to predict exactly how long that will take,” he said.

Earnings, results

Chesapeake did not repurchase any shares in the first quarter due to the pending merger.  

Net production in the first quarter was at a low end of expectations at approximately 3.20 Bcfe per day (100% natural gas), with an average of nine rigs to drill 28 wells and place 29 wells on production.

Adjusted EBITDAX was $508 million and free cash flow was $131 million.

The company will return approximately $0.72 per common share for base and variable dividends to shareholders of record as of May 16.