Chesapeake Energy 1996 Annual Report Download - page 12

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CHESAPEAKE ENERGY CORPORATION
Superior profit margin
COMPETITIVE ADVANTAGE N°. 4
Chesapeake's fourth competitive
advantage is our high profit
margin per-unit-of-produc-
tion. During fiscal 1996, this mar-
gin was $0.77 per Mcfe, the highest
in our peer group. This margin is de-
fined as oil and natural gas revenues
minus lease operating costs (which in-
clude lease operating expenses and
production taxes), general and ad-
ministrative expenses, and oil and gas
depreciation, depletion, and amorti-
Chesapeake's low-cost operating
structure and drilling efficiencies
generate the highest profit margins
in the compans peer group.
iation expenses. We believe the key
to creating shareholder value is gen-
erating large amounts of cash flow
from Chesapeake's superior profit
margin and then reinvesting this cash
flow into the profitable search for new
reserves.
We have developed our company's
low cost structure by:
Utilizing advanced drilling and
completion technologies to
reduce the cost of finding and
producing the company's oil
and natural gas reserves;
Concentrating the company's
drilling in areas which provide
the critical mass necessary to
spread operating and overhead
costs over a large number of
we! Is;
Operating 87% of the
company's production, thereby
allowing our employees to
implement the most cost-
effective and technologically
sophisticated drilling,
completing, and operat-
in procedures; and
Maintaining a flat
organizational structure
with performance-based
pay and stock option
incentives to motivate
Chesapeake's employees
so they can quickly respond to
attractive opportunities.
Although we believe continuing
worldwide economic growth may
cause oil and gas prices to increase,
Chesapeake budgets for inflation-ad-
justed prices to remain flat in the
coming years. Therefore, manage-
ment believes the most profitable Mcf
of gas or barrel of oil that can be pro-
duced is the one produced today.
Long-lived reserves, which are
burdened by future operating, financ-
LETTER TO SHAREHOLDERS
Profit Margin Advantage
ing, and administrative costs and are
adversely effected by the time value
of money and the risk of future me-
chanical problems, are less valuable
than reserves that can be monetized
more quickly. Consequently, reserves
produced in a shorter time frame have
higher profit margins and therefore
are more likely to create shareholder
value than longer-lived reserves.
Chesapeake attempts to develop
large per-well oil and natural gas re-
serves with an average life of five to
seven years, intentionally shorter than
the industry average of eight to ten
years. The combination of accelerat-
ing the production of reserves, gen-
erating high cash flows from the pro-
duction, and then successfully rein-
vesting the cash flows into a techno-
logically advanced exploration pro-
gram is the formula that we believe
can provide Chesapeake's sharehold-
ers with increasing value.