What If Chesapeake Production Cuts Work? (CHK, PXP, BP)

Chesapeake Energy Corporation (NYSE: CHK) is tired of not having profitable results from a key operation.  The largest natural gas player announced that it will cut its production by 7% and is considering a further reduction of 10% in drilling for 2009. Natural gas prices of about $2.70/thousand cubic feet get the blame. According to the company’s CEO, that’s a price at which most natural gas production is unprofitable.

The company expects the low prices to constrain drilling across the industry, and for demand to pick up by the end of the year, “if not sooner.” Chesapeake does not say why it thinks demand will pick up.

Chesapeake also had to rewrite its joint venture agreement with Plains Exploration & Production Company (NYSE: PXP). The $1.65 billion deal counted on higher gas prices and steadier production from Chesapeake’s Haynesville Shale. Chesapeake has granted Plains a one-time option, exercisable from June 15, 2010, through June 30, 2010, to skip paying the final installment on the purchase. If Plains should exercise its option, it will need to return 50% of all the joint venture assets to Chesapeake. Chesapeake estimates that the value of Plains’  investment will have about doubled by the end of 2010. Plains remains on the hook for paying for 50% of Chesapeake’s drilling costs through December 2010.

Chesapeake’s shares are down around 7% this morning, and Plains’s shares are down about 6%. As Chesapeake’s share price falls, will the rumors about a takeover by BP plc (NYSE: BP) start up again?

Paul Ausick
March 2, 2009