Chesapeake Energy Corp. (NYSE: CHK) opened about 2% higher this morning following its third-quarter earnings release after markets closed yesterday. The company posted adjusted EPS of $0.72, beating the consensus estimate by $0.04. Revenue totaled $3.977 billion, again handily beating the estimate of $3.14 billion. Chesapeake trails only Exxon Mobil Corp. (NYSE: XOM) in natural gas production, and leads Anadarko Petroleum Corp. (NYSE: APC) and Devon Energy Corp. (NYSE: DVN) in third and fourth place, respectively.

At the same time that it released earnings, Chesapeake said that it was in the process of selling about $3.4 billion in assets. There are two pieces to the sales. First, an unnamed major international energy company is expected to pay $2.14 billion for a 25% interest in 650,000 net acres Chesapeake controls in the Utica shale play. The company also plans to sell preferred shares worth $500 million in a new subsidiary to a privately held energy company and another $750 million in preferred shares of the same subsidiary to other investors. Chesapeake, as is its common practice, will use proceeds from the sale to support its drilling operations in the Utica shale play.

There are several interesting tidbits in the company’s report. Liquids, including oil and natural gas liquids, now accounts for 17% of total production, up from 10% in the same period a year ago. As a percentage of realized revenue, liquids account for 31% of total revenue, and as a percentage of revenue, liquids contribute 40% of unhedged revenue. The average realized price for barrel of liquids was $63.03 in the third quarter, up from $59.81 a year ago.

Natural gas accounts for 83% of production, down from 90% a year ago; 69% of total revenue; and 60% of unhedged revenue. The company’s average realized price for a thousand cubic feet of natural gas was $4.82, compared with $5.20 a year ago, and $5.19 in the second quarter of this year. Natural gas production was essentially flat, at 254 billion cubic feet in the quarter, compared with 253 billion cubic feet in the same period last year. Sequentially, natural gas production rose by 20 billion cubic feet.

Like every other natural gas producer, Chesapeake relies on its liquids production to maintain revenues and profits with natural gas prices below $5/thousand  cubic feet. And greater volumes of natural gas coming into production are not likely to boost the price.

Chesapeake’s business depends on being the first to stake a claim in new shale play, to buy up as many acres as it can, and then to parcel off the assets for cash and a stake in production. CEO Aubrey McClendon calls this the “asset harvest.” As long as the company can keep discovering new deposits it doesn’t have to worry too much about low natural gas prices because it collects a decent sized portion of its original investment up front and leaves its partners to worry about the rise and fall in commodity prices.

If or when the going gets tough, the company can dump its all its assets in a particular play and go hunting and gathering elsewhere, as it did when it sold all its remaining stake in the Fayetteville shale to BHP Billiton plc (NYSE: BHP) for about $4.75 billion. The company had sold a 25% stake in the Fayetteville to BP plc (NYSE: BP) for $1.9 billion in 2008.

In January, the company announced a plan to reduce its long-term debt by 25% and increase production by 25% by the end of 2012. At the time, long-term debt stood at $12.64 billion. At the end of the third quarter, long-term debt stood at $11.8 billion. That’s about a 7% reduction so far, with five quarters still to go.

Following a burst of enthusiasm in after-hours trading last night and pre-market trading this morning, Chesapeake shares are down more than -7% in the first hour of trading this morning, at $26.90, in a 52-week range of $21.11-$35.95.

Paul Ausick

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