Future is bright for these gas producers

CHESAPEAKE ENERGY $23.51 (New York symbol CHK; SI Rating: Extra risk) (405-848-8000; www.chkenergy.com; Shares outstanding: 654.3 million; Market cap: $15.4 billion; Dividend yield: 1.3%) is a major U.S. natural-gas producer. Gas makes up 90% of its production.

Chesapeake focuses on onshore conventional and unconventional gas reserves. It has a leading position in nearly every major unconventional discovery in the U.S. east of the Rockies, including the Barnett Shale in Texas; the Haynesville and Bossier Shales in Louisiana and Texas; the Fayetteville Shale in Arkansas; the Marcellus Shale in the West Virginia, Pennsylvania and New York; and the Eagle Ford Shale in Texas.

Shale gas is natural gas that is trapped in rock formations. To extract it, companies use highly pressurized water and sand to crack the shale. Extraction methods are constantly improving, and steadily increasing shale-gas production.

Chesapeake’s production averaged 3.0 billion cubic feet equivalent per day in the three months ended September 30, 2010, up 22.5% from 2.5 billion a year earlier. Even so, cash flow per share fell 6.1%, to $1.69 from $1.80, due to lower realized oil and gas prices. Chesapeake now trades at about 4.6 times its forecast 2011 cash flow. Its debt is 74% of its market cap.

The company’s aggressive drilling efforts continue to be successful. In the first three quarters of 2010, it drilled 1,041 wells, with a 99% success rate.

To fund its drilling, Chesapeake is selling interests in its properties. So far this year, it has raised $4.7 billion in eight “volumetric production payment” sales. These sales give the buyer a share of current production, but Chesapeake operates the wells and keeps future drilling and production rights on the properties.

As well, the company just sold a 33.3% interest in the Eagle Ford Shale to Chinese oil giant CNOOC for $1.08 billion. CNOOC will also pay for 75% of the drilling and development costs, up to $1.08 billion.

Chesapeake is still a buy for aggressive investors.

DEVON ENERGY CORP. $73.17 (New York symbol DVN; SI Rating: Speculative) (405-235-3611; www.devonenergy.com; Shares outstanding: 435.0 million; Market cap: $31.8 billion; Dividend yield: 0.9%) is one of the largest U.S.-based oil and natural-gas explorers and producers. Its production mix is 69% gas and 31% oil.

Devon has completed the sale of its Gulf of Mexico properties, which it saw as risky and expensive to develop. The company is using the over $8 billion in after-tax proceeds to buy back shares, add properties and pay down debt. Its long-term debt is now just $3.8 billion, or 11.9% of its market cap. The company holds cash of $3.6 billion, or $8.28 a share.

Devon is now focused on its North American properties. Apart from conventional production, these include shale oil in Texas and oil sands in Canada.

In the three months ended September 30, 2010, higher oil and gas prices pushed up Devon’s cash flow per share by 60.4%, to $3.77 from $2.35. On a daily basis, Devon produced 2.5 billion cubic feet of natural gas and 192,700 barrels of oil.

Devon’s shares trade at 6.4 times the company’s forecast 2011 cash flow of $11.50 a share.

Devon Energy is a buy.