Chesapeake Energy Corp. (NYSE: CHK) set two goals last year: first, to reduce long-term debt by 25% by the end of 2012; and second, to increase production by 30%. The company said today debt has dropped from $12.5 billion at the end of 2010 to $10.3 billion at the end of 2011. By the end of this year, long-term debt is planned to fall to $9.5 billion.

Interestingly, Chesapeake expects to reach this debt level “regardless of the price of natural gas” in 2012. The company’s production increased by 15% in 2011, but production increases are offset by low pricing for natural gas:

[I]f natural gas prices remain at currently depressed levels, Chesapeake will further reduce its drilling capital expenditures on dry natural gas plays, which would likely decrease its projected natural gas production and could reduce its two-year production growth target below 30%.

Like other natural gas producers, Chesapeake pays for its operations by producing natural gas liquids or crude oil, both of which have premium pricing compared with natural gas which is hovering around $3/thousand cubic feet. To make a profit on natural gas alone, prices have to rise to more than $6/thousand cubic feet. That’s no likely to happen in the next year or even the next two years.

When the company’s CEO announced the debt reduction plan in January 2011, he said:

This plan represents a fundamental shift from our aggressive asset accumulation of the past few years to a multi-year period of asset harvest, characterized by a clear focus on capital discipline and maximizing returns.

Chesapeake sold off about 2.8 trillion cubic feet (Tcf) of reserves in 2011, but still managed to increase its reserves during the year by 10%, to around 18.8 Tcf equivalent. Reserves accumulation, typically through being the first company to sign leases with landowners, is Chesapeake’s currency for its drilling programs.

The company’s model has worked so far because Chesapeake has been able to keep its capital costs reasonable. But it’s worth noting that Chesapeake’s shares once traded at around $67, almost triple today’s levels. The pile-up of debt contributed to that share-price slide at least as much as the collapse in natural gas prices.

Chesapeake shares are trading at $23.77 this morning, in a 52-week range of $22.00-$35.95.

Paul Ausick

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