Chesapeake Hedges Nearly All Expected 2011 Gas Production to Reduce Debt

For my best stock for 2011 selection, I went with low-cost natural gas producer Range Resources (RRC) on the off chance that this might be the year that natural gas drags itself off the mat. Chesapeake Energy (CHK) appears to have ruled out this possibility.

In an operational update released yesterday, Chesapeake revealed that it has hedged 96% of its expected natural gas production for 2011. I can't remember a time when the company has ever locked in virtually all of its production like this. At an average price of $5.84 per thousand cubic feet, though, the company is getting a strong realized price relative to where gas trades today. That $5.84 is even a premium to where the January 2013 futures trade.

While investors banking on higher gas prices in 2011 will probably want to place their bets elsewhere, I can't fault Chesapeake for this hedging move, especially considering the company's intended use of having the cash flows locked in.

Another major piece of Chesapeake's update yesterday was the announcement of a new "25/25 Plan," through which Chesapeake intends to reduce long-term debt by 25% over the next two years, while maintaining a production growth rate of 25%. The hedging program adds a great amount of certainty to the company's ability to fund this debt reduction. Chesapeake will also continue to monetize assets, as it has done with partners like CNOOC (CEO) and Plains Exploration & Production (PXP) over the past few years.

This isn't the first time Chesapeake has spoken about reducing debt, but it is a more coherent and credible statement than the one released last May. Back then, Chesapeake said its plan to reduce debt was to raise $5 billion to retire up to $3.5 billion, while spending up to $1.5 billion on liquids-rich plays. That one was a head-scratcher. This time around, it sounds like Chesapeake is finally ready to cool it with the land grabs.

This is a pretty big breakthrough, if it sticks. The move mirrors one taken by Devon Energy (DVN), which has also shed the empire-building routine and turned its focus to developing its existing captured resource base. Investors appear to have warmed to that company as it undertakes the transformation.

I'm thinking that Chesapeake, which has been more reluctant to let go of its expansionary ways, may see a similar change in fortune for its share price. I also can't help but wonder if recent pressure from a certain prominent shareholder helped management to see the light here.