Chesapeake Energy 2005 Annual Report Download - page 12

to our investors. I often believe that many investors do not fully
appreciate how much risk there is in this industry and how well we
manage it at Chesapeake. For example, in 2006 when natural gas
prices are widely expected to decline to below $6 per mmbtu by late
summer because of this past winter’s record warmth, we have hedged
71% of our 2006 natural gas production at $9.43 per mmbtu, 36%
of our 2007 natural gas production at $9.85 per mmbtu and 22% of
our 2008 natural gas production at $9.10 per mmbtu (excluding
CNR hedges).
Additionally, we are the only E&P company that has significantly
hedged its exposure to rising service costs by building drilling rigs
and investing in related service industry providers. To date, these
investments have appreciated in value by roughly $250 million. We
now own 32 rigs outright and have an additional 25 on order, which
should account for approximately 60% of the rigs we plan to operate
a year from now. Rig ownership is proving to be an extremely valuable
competitive advantage in both acquisitions and in operations.
Moreover, in a time of increasing geopolitical unrest around the
world, the prospect of asset loss in many areas of the world to arbitrary
tax and royalty changes or even outright contract cancellation by
foreign governments is a serious concern faced by all major integrated
oil companies and many large independent E&P companies. Except
for occasional chatter about a windfall profits tax in the U.S.,
Chesapeake’s assets are safe from such political risks.
I also emphasize that Chesapeake’s assets are all high and dry
onshore in the U.S. In a time of what appears to be a cycle of greater
hurricane activity in the Gulf of Mexico, many investors may not fully
appreciate the very high risks that Gulf of Mexico operators and
investors may face in hurricane seasons to come.
Not having access to rigs to develop our assets or owning assets
subject to confiscation by some foreign potentate or suffering damage
from hurricanes are risks to which we have no exposure. That is why,
dollar for dollar, we believe investors can achieve the very best risk-
adjusted returns in the industry right here at CHK.
OPPORTUNITY Now let’s talk about opportunity. Much
earlier than most companies, in fact as far back as 1998 and 1999,
Chesapeake’s management team anticipated changing industry
conditions and quickly recognized the trends that have driven
remarkable increases in oil and natural gas prices during the past
eight years. We also recognized the need to develop the building
blocks of future value creation in the E&P business – people, land
and science.
During the past eight years we have aggressively captured
opportunities in each of these critical areas. For example, before
talented people became scarce in this industry, we were hiring them
by the hundreds. Before prospects and leases became scarce, we
built a system of prospect generation and leasehold acquisition that
is second to none in the industry. And finally, when others were
reluctant to invest in science and new ideas, we aggressively entered
into virtually every major natural gas resource play in the U.S. east
of the Rockies.
Chesapeake has significantly strengthened its technical capabilities
during the past eight years by dramatically increasing its land,
geoscience and engineering staff to more than 600 employees. In
“Additionally, we are the
only E&P company that
has significantly hedged
its exposure to rising
service costs by building
drilling rigs and investing
in related service indus-
try providers. To date,
these investments have
appreciated in value by
roughly $250 million.”
8 CHK 2005 ANNUAL REPORT