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Chesapeake’s Business Strategy

Since our inception in 1989, Chesapeake's goal has been to create value for investors by building one of the largest onshore natural gas resource bases in the United States.  For the past ten years, our strategy to accomplish this goal has been to focus onshore in the U.S. east of the Rockies, where we believe we can generate the most attractive risk adjusted returns.  In building our industry-leading resource bas during the period from 1998-2007, we integrated an aggressive and technologically-advanced drilling program with an active property consolidation program focused on small to medium-sized corporate and property acquisitions.  During the past two years, we have shifted our strategy from drilling inventory capture to drilling inventory conversion.  In doing so, we have de-emphasized acquisitions of proved properties while further emphasizing our industry-leading drilling program and converting our substantial backlog of drilling opportunities into proved developed producing reserves. 

Below we detail several key elements of our business strategy which include:

  • Grow through the Drillbit
  • Control Substantial Land and Drilling Location Inventories 
  • Develop Proprietary Technological Advantages
  • Build Regional Scale
  • Focus on Low Costs
  • Mitigate Commodity Price Risk
  • Maintain an Entrepreneurial Culture
  • Improve our Balance Sheet  

Grow Through the Drillbit

We believe that our most distinctive characteristic is our commitment and ability to grow production and reserves through the drillbit.  We are currently utilizing 145 operated drilling rigs and approximately 91 non-operated drilling rigs to conduct the most active drilling program in the U.S.  We are active in most of the unconventional plays in the U.S east of the Rockies where we will drill more horizontal wells than any other company in the industry.  For the past ten years, we have been actively investing in leasehold, 3-D seismic information and human capital to take advantage of the favorable drilling economics that exist today.  We are one of the few large-cap independent natural gas and oil companies that have been able to consistently increase production, which we have successfully achieved for the past 18 consecutive years and 27 consecutive quarters.  We believe key elements of the success and scale of our drilling programs have been our recognition earlier than most of our competitors that (i) natural gas and oil prices were likely to move structurally higher for an extended period (ii) new horizontal drilling and completion techniques would enable development of previously uneconomic natural gas reservoirs and (iii) various shale formations could be recognized and developed as potentially prolific natural gas reservoirs rather than just as sources of natural gas.  In response to our early recognition of these trends we have proactively hired thousands of new employees and have built the nation’s largest onshore leasehold and 3-D seismic inventories, the building blocks of a successful large-scale drilling program and the foundation of value creation in our industry.

Control Substantial Land and Drilling Location Inventories

After we identified the trends discussed above, we initiated a plan to build and maintain the largest inventory of onshore drilling opportunities in the U.S.  Anticipating an increase in commodity prices and recognizing that better horizontal drilling and completion technologies when applied to various new shale plays would likely create a unique opportunity to capture decades worth of drilling opportunities, we embarked on a very aggressive lease acquisition program which we have referred to as the "land grab".  We believed that the winner of the "land grab" would enjoy a distinctive competitive advantage for decades to come as other companies would be locked out of the best new shale plays in the U.S.  We believe that we have executed our "land grab" strategy with particular distinction.  We now own approximately 13.9 million net acres of leasehold in the U.S. and have identified more than 33,700 net drilling opportunities on this leasehold.  We believe this deep backlog of drilling, more than ten years worth at current drilling levels, provides unusual confidence and transparency into our future growth capabilities.

Develop Proprietary Technological Advantages

In addition to our industry-leading leasehold position, we have developed a number of proprietary technological advantages.  First, we have acquired what we believe is the nation's largest inventory of three-dimensional (3-D) seismic information.  Possessing this 3-D inventory enables us to image deep reservoirs of natural gas that might otherwise remain undiscovered and to drill our horizontal wells more accurately inside the targeted shale formation.  In addition, we have developed an industry-leading information-gathering program that gives us proprietary insights into new plays and competitor activity.  As a result of our initiatives, we now produce approximately 4% of the nation's natural gas, drill 8% of it's wells and participate in almost an equal number of wells drilled by others.  Consequently, we believe that we recieve drilling information on 20-25% of the wells in areas in which we are focused.  By gathering this information on a real-time basis, then quickly assimilating and analyzing the information, we are able to react quickly to opportunities that are created through our drilling program and those of our competitors.  Finally, we have recently constructed a unique state-of-the-art Reservoir Technology Center (RTC) in Oklahoma City.  The RTC enables us to more quickly, accurately and confidentially analyze core data from shale wells and then design fracture stimulation procedures that are designed to work most productively in the shale formations that have been analyzed.  We believe the RTC provides a very substantial competitive advantage in developing new shale plays and improving existing shale plays.    

 

Build Regional Scale

We believe one of the keys to success in the natural gas exploration industry is to build significant operating scale in a limited number of operating areas that share many similar geological and operational characteristics.  Achieving such scale provides many benefits, the most important of which are superior geoscientific and engineering information, higher per unit revenues, lower per unit operating costs, greater rates of drilling success, higher returns from more easily integrated acquisitions and higher returns on drilling investments.  We first began pursuing this focused strategy in the Mid-Continent region ten years ago and we are now the largest natural gas producer, the most active driller and the most active acquirer of leasehold and producing properties in the Mid-Continent.  We believe this region, which trails only the Gulf Coast and Rocky Mountains in current U.S. natural gas production, has many attractive characteristics.  These characteristics include long-lived natural gas properties with predictable decline curves, multi-pay geological targets that decrease drilling risk and have resulted in a drilling success rate of 98% over the past 18 years, generally lower service costs than in more competitive or more remote basins and a favorable regulatory environment with virtually no federal land ownership.  We believe the other areas where we operate possess many of these same favorable characteristics and our goal is to become or remain a top three natural gas producer in each of our operating areas.

Focus on Low Costs

By minimizing lease operating costs and general and administrative expenses through focused activities and increased scale, we have been able to deliver attractive financial returns through all phases of the commodity price cycle.  We believe our low cost structure is the result of management's effective cost-control programs, a high-quality asset base, extensive and competitive services and natural gas processing and transportation infrastructures that exist in our key operating areas.  In addition, to control costs and service quality, we have made significant investments in our drilling rig and trucking service operations and in our midstream gathering and compression operations.  As of March 31, 2008, we operated approximately 22,600 of our 39,200 wells, which delivered approximately 85% of our daily production volume.  This large percentage of operated properties provides us with a high degree of operating flexibility and cost control.

Mitigate Commodity Price Risk

We have used and intend to continue using hedging programs to seek to mitigate the risks inherent in developing and producing natural gas and oil reserves, commodities that are frequently characterized by significant price volatility.  We believe this price volatility is likely to continue in the years ahead and that we can use this volatility to our benefit by taking advantage of prices when they reach levels that management believes are either unsustainable for the long-term or provide unusually high rates of return on our invested capital.  As of  May 1, 2008, we have natural gas hedges in place covering 74% and 80% of our expected natural gas production in 2008 and 2009, respectively and oil hedges in place covering 72% and 92% of our expected oil production in 2008 and 2009, respectively, thereby providing price certainty for a substantial portion of our future cash flow.

Maintain an Entrepreneurial Culture

Chesapeake was formed in 1989 with an initial capitalization of $50,000 and fewer than ten employees.  Since then, our management team has guided the company through various operational and industry challenges and extremes of natural gas and oil prices to create the second-largest independent producer of natural gas in the U.S. with 6,600 employees currently and an enterprise value of approximately $39.5 billion.  The company takes pride in its innovative and aggressive implementation of its business strategy and strives to be as entrepreneurial today as it has been in its past.  We have maintained an unusually flat organizational structure as we have grown to help ensure that important information travels rapidly through the company and decisions are made and implemented quickly.  Our chief executive officer and co-founder, Aubrey K. McClendon, has been in the natural gas and oil industry for 27 years and beneficially owns, as of May 1, 2008, approximately 29.5 million shares of our common stock.       

Improve our Balance Sheet

We have made significant progress in improving our balance sheet over the past nine years.  From December 31, 1998 through March 31, 2008, we increased our stockholders' equity by 11.7 billion through a combination of earnings and common and preferred equity issuances.  As of March 31, 2008, our debt as a percentage of total capitalization (total capitalization is the sum of debt and stockholders’ equity) was 52%, compared to 137% as of December 31, 1998

Outlook

We believe that demand for natural gas will continue to increase in the U.S. and around the world as a result of its favorable environmental characteristics and relative abundance, especially when compared to oil, which is in increasingly short supply, and to coal, which has many unfavorable environmental characteristics.  Chesapeake's strategy for 2008 is to continue developing our natural gas assets through exploratory and developmental drilling and by selectively acquiring strategic properties in the Mid-Continent and in our other operating areas.  We project that our 2008 production will be between 857 bcfe and 867 bcfe, a 20% to 22% increase over 2007 production.  Also for 2008 we have budgeted $5.3 billion for drilling, acreage acquisition, seismic and related capitalized internal costs net of leasehold producing property sales, which is expected to be funded with operating cash flow based on our current assumptions, and borrowings under our revolving bank credit facility.  Our budget is frequently adjusted based on changes in natural gas and oil prices, drilling results, drilling costs, and other factors.