Is Chesapeake Energy in Danger?

For Chesapeake Energy (CHK) things aren’t in good health. The stock has lost more than 57% of its market capitalization so far this year. This drop in the stock’s market capitalization is due to a variety of factors such as suspension of preferred dividend, recent debt exchange and continued slump in the oil price.

Feeling the pain

Recently, Chesapeake Energy had announced that it would suspend payments of dividend for its preferred stock instantly. Its Chief Executive Officer Doug Lawler said, “The board and management believe this decision is in the best long-term interest of all Company stakeholders.
Today's decision to suspend our preferred stock dividends will allow the company to retain approximately $170 million of additional cash per year and use these funds to purchase debt at significant discounts in the near term”.

More importantly, the company had previously issued senior secure notes of $3.8 billion in an attempt to reduce its debt burden of $11.6 billion and gain the confidence of investors. However, this didn’t work for Chesapeake Energy, as the company experienced minimum participation for its highest priority bonds, which were payable in 2017 and 2018.

Nevertheless, this very act assisted the company to escape from near certain-bankruptcy, as Chesapeake Energy had lost more than 78% of its market value prior to this in a span of twelve months. But, this didn’t last longer as the continued downturn in the oil and gas price further weakened the value for its shares. At present, the stock looks bleak with little or no hope of reviving in the short run.

What next?

According to a report by Energy Information Administration, the monthly average Henry Hub spot prices for natural gas will remain low in 2016, due to continued blockage from increased level of inventory and production growth. EIA expects the Henry Hub natural gas price to average $2.64 MMBtu in 2016 and $3.22 MMBtu in 2017.

Additionally, EIA expects the consumption of natural gas for power generation to shrink by 0.2% or 0.1 Bcf/d in 2016 and a 0.9% drop in 2017. This drop in the consumption of natural gas for power generation at relatively lower price will impact the overall demand for natural gas negatively. Power generation that represents the highest 35% of the total natural gas demand had consumed approximately 26.47 billion cubic feet per day of natural gas in 2015.

What's more, the crude oil fundamentals do not appear attractive in the short-run due to increasing production level for crude oil from OPEC regions. EIA anticipates the crude oil production from the OPEC region to grow 3% to 39.20 million barrels in 2016 and an incremental 2% to 40.07 in 2017 respectively. In fact, this growth in the crude oil production is relatively higher than Non-OPEC region’s efforts of curtailing their crude oil production. The non-OPEC regions are planning to cut their crude production by only 1% in 2016 and 0.3% in 2017 respectively.

However, in the long-run this gap is expected to get corrected due to continued efforts of reducing the crude oil production level from non-OPEC and strong long-term demand for crude oil. EIA anticipates the OPEC production to gradually moderate in 2016 other than Iran, which is likely to witness growth in crude oil production.

Although, the short-term outlook for oil and natural gas is not appealing, Chesapeake Energy is likely to focus largely on gas production. This is due to the fact that most of its natural gas production assets such as Haynesville, Utica Dry, Utica Wet and Marcellus have break-even of more or less at $2.50 MMBtu. It has been viewed above that the average natural gas price will come in at $2.64 MMBtu in 2016 and $3.22 MMBtu in 2017. This means the company can still benefit from its highly efficient natural gas asset portfolio and create value for its share holder even in this low commodity price environment.

In addition, the company continues to optimize production base at these core assets through various programs such as Chock management, compressor or artificial lift optimization, pressure maintenance programs and by way of continuously extending laterals. As a result of this optimization programs, the company witnessed approximately 12% increase in production base in the first-half of 2015 at its Utica shale.

More positives to consider

Chesapeake Energy has made significant progress with respect to production costs and drilling efficiencies, which cannot be overruled in this low-oil-price environment. For instance, Chesapeake Energy has considerably reduced its drilling costs per foot at Haynesville to $209 million in the third-quarter of 2015, a drop of 24% as compared to $275 million in the third-quarter of 2014. In fact, the company managed to reduce the drilling costs by over 11% sequentially, as shown in the chart below.

Moreover, the company continues to drive cash cost reductions on an absolute and per unit basis. For example, the company during the third-quarter lowered its lease operating and G&A costs by 9% to $4.88 per barrel of oil equivalent year-on-year basis, and approximately by 10% sequentially. These costs reduction efforts should further optimize its asset base and increase efficiency for its assets, while creating value for its shareholders and investors.

Chesapeake Energy continues to make progress on reducing production costs and increasing drilling efficiencies. This is helping the company, alleviating the impact of low-oil price environment.

Reduction in capital expenditure and sale of non-core assets to improve its financial flexibility

Chesapeake Energy has significantly reduced its capital expenditure throughout 2015 by way of various capital efficiency programs such as deployment of innovative technologies and drilling longer-laterals across its asset portfolio. As a result of these deployments, the company improved its capital efficiencies by 20% -25% across its operation. The chart below shows its laterals in 2015 versus 2014.

These capital efficiency gains allowed the company to further reduce its capital expenditure by over $100 million to the range of $3.4 billion to $3.9 billion. In fact, the company is planning to further reduce its capital expenditure in 2016 that should provide better financial flexibility in this low oil price set up. Apart from this reduction in capital expenditure, the company is selling off its non-core assets. For instance, the company is on the track to sell approximately $200 million to $300 million of non-core assets in the fourth-quarter of 2015, and the first-quarter of 2016.

This is a good move, it will help the company to reduce its net debt and improve its liquidity position. The company has total debt of $11.6 billion and total cash of $1.76 billion at the end of third-quarter of 2015. Chesapeake Energy has operating cash flow of $1.88 billion for the trailing twelve months.

Conclusion

Chesapeake Energy is making significant progress on the operational side. It has optimized production base across its asset portfolio and consistently increasing efficiencies of these assets. Also, it has extensively reduced drilling and completion costs that should enable the company to partially offset the low oil price environment.
Published on Feb 24, 2016
By Vinay Singh

Copyrighted 2016. Content published with author's permission.

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