Chesapeake Energy (CHK) knows the value of a dollar today.  On Wednesday the company announced it had ammended a joint venture agreement with Plains Exploration & Production Company (PXP) in order to receive an up front payment that had previously been scheduled to last over a three year period.  According to the deal, PXP will pay $1.1 billion to Chesapeake on September 29, which represents a 12% reduction in the total drilling obligations, but gives Chesapeake access to the capital right away.

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The announcement came just three days after Chesapeake announced earnings for the second quarter.  Adjusted EPS came in at $0.62 per share as natural gas production ticked up slightly over first quarter production.  More importantly, the company was able to increase their “proved reserves” and show progress in drilling programs during the first half of the year.  The company’s heding program also turned out to be beneficial with a realized gain of $597 million.  But despite the positive operational results, the balance sheet and cash liquidity certainly pose risk to current investors.

At the end of the second quarter, Chesapeake had a cash balance of $554 million which was down from $1.75 billion at the end of 2008.  Whiel the magnitude of the numbers is astounding, $500 million can quickly evaporate with aggressive drilling programs, current liabilities of $2.97 billion, and long-term debt of $13.6 billion – especially considering the volatility in natural gas prices over the past 18 months.  While the company has some very impressive properties it could liquidate in the event they faced a cash crisis, a forced sale never yields attractive valuation, so the proactive step of collecting cash from PXP looks very wise.

This agreement modification provides substantial upfront capital to Chesapeake, reduces PXP’s total investment in the Haynesville and further aligns the incentives between the partners. The Haynesville joint venture has been highly successful to date and we look forward to generating strong reserve and production growth as well as very attractive financial returns for both companies in the years ahead. ~Aubrey K. McClendon, CEO

Chesapeake has done an excellent job of growing its reserve base through organic exploration and development, as well as through strategic acquisitions and joint ventures.  At the end of June, Chesapeake was sitting on 12.5 TCFE (Trillion Cubic Feet Equivalent) and expects to grow this to 14.0 TCFE by the end of the year.  At the end of 2010, the company expects this metric to hit 16.0 which should provide investors with an attractive asset base from which to grow long-term earnings.

There are many different approaches a natural gas producer can take.  While Chesapeake holds a well diversified selection of properties, the company has been careful to invest in locations where production falls within the company’s skill set.  All of its properties are onshore US based properties which allows the company to avoid political turmoil, and miss most of the carnage that has hit off-shore producers in the path of recent hurricanes.  Cutting out these risks may keep the company from pursuing some good opportunities, but the security of its natural resources appears to be working to shareholders’ advantage.

ZachStocks has avoided traditional energy plays for some time as the prices for oil and natural gas offered investors very little return considering the risk being taken.  At this point it now looks like the tables are turning, and some traditional energy names could be in play along with alternative energy names we have been trading.  Commodity prices are likely to catch a bid in coming months – especially if the “recovering economy” story continues to hold.  Limits on position sizes for commodities will not likely have a long-term effect on holding prices lower as supply and demand forces are much stronger.  So adding exposure to traditional energy producers appears to make sense in the coming months and Chesapeake is certainly a leader in the space.

FD: Author does not have a position in CHK

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