Why Chesapeake expects to spend less but produce more in 2014
Chesapeake plans to reduce capex in 2014 versus 2013
Chesapeake Energy announced that it had planned capital expenditures of $5.2 billion to 5.6 billion in 2014. This represents a 20% decrease from the company’s 2013 capex budget. The majority of capital expenditure budgets of oil and gas producers is usually directed towards drilling and completing wells, and normally a reduction in capex might imply declining production, as it suggests that fewer wells would be completed.
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Production expected to grow year-over-year
However, CHK management stated that despite a reduction in spending, it still expects to grow its oil and gas production by 2-4% on an absolute level in 2014 compared to 2013, and 8% to 10% adjusted for asset sales. The company noted that it would grow its liquids production by 14% to 18% (comprised of 1% to 5% oil growth, and 40% to 45% natural gas liquids growth), with natural gas production flat to down 2%. In total for 2014, the company expects production of 680 thousand to 695 thousand barrels of oil equivalent per day, with roughly 29% of production contribution from oil or natural gas liquids.
That the company is able to grow production while cutting back a major cost (capex) is a positive signal. This means that Chesapeake is able to spend less money to generate more production, which (if commodity prices are stable or up) means higher revenues and earnings. Chesapeake noted that it will be able to cut spending while growing production—in part due to supply chain management initiatives that leverage Chesapeake’s size and purchasing power, which in turn generates capital efficiencies.
The way capex is treated in accounting is it immediately affects the cash flow statement for the period in which it’s spent. However, capex hits earnings over time, as the effect of the cash expense spreads out over numerous periods in the depreciation, depletion, and amortization expense line of the income statement. So lower capex has the immediate effect of increasing Chesapeake’s free cash flow (or making it less negative), and having a more prolonged but more gradual effect on net income through a decrease in the non-cash expense line of DD&A. In either case, this is positive for the company’s valuation.
CHK also disclosed its December 2013 production rates. The company notes that at year end 2013, it was producing roughly 649,000 barrels of oil equivalent per day. Management commented that severe weather at the end of 2013 and in 1Q14 would depress production rates, but that production would ramp significantly into 2Q14 to reach the forecasted production rate of 680,000 to 695,000 barrels of oil equivalent per day through 2014.
Over the long term, the company’s goal is to grow debt-adjusted production per share at 5% to 9% annually, citing continued capital efficiencies.