Of all the companies that have been hammered by the Oil Crisis, few have been hit as hard as Chesapeake Energy Corporation. CHK’s stock market valuation today is about $1 billion versus more than $20 billion a year ago. The stock today trades at less than $2 a share after having reported EPS losses over the last year of more than $18 per share. In short, it has been a really rough ride for CHK and its shareholders.
To the extent that the stock market is behaving rationally, investors clearly are pricing in a very real risk that Chesapeake may have to enter bankruptcy in the future. No one knows if that will happen of course, and it is certainly worth noting that Chesapeake has a cogent plan to pay off its $500 million in maturing debt that comes due in March.
The firm plans to use a combination of cash on hand and additional liquidity including perhaps drawing on existing credit lines. For 2017, CHK has more than $1 billion in debt maturing, and the firm is planning on selling assets to cover those needs. Thus it’s not as though management is sitting on the deck fiddling as the CHK ship heads for an iceberg. Yet, for all of management’s efforts, it’s unclear if the firm will ultimately avoid bankruptcy or not.
The possibility of a Chesapeake bankruptcy raises an interesting question; what will happen to natural gas prices if the U.S.’ second largest producer of the product declares bankruptcy? The obvious point that anyone familiar with U.S. bankruptcy would make is that a CHK bankruptcy would almost certainly be a Chapter 11 reorganization rather than a Chapter 7 liquidation. In other words, natural gas would likely continue to flow from CHK wells even in a bankruptcy proceeding.
Yet there is a scenario in which CHK’s bankruptcy could cause a dramatic change in natural gas prices. Energy company bankruptcies have always been very messy and they are getting even messier. For instance, when Quicksilver recently declared bankruptcy, it took 10 months to auction off its oil and natural gas acreage with bids fetching less than $250 million - about a fifth of what had been expected in advance.
A Chesapeake bankruptcy would be considerably more complicated and with the glut of assets up for sale, prices received in auction – even for part of the company – would likely be a pittance. Given that, there is a very real chance that several events will occur if CHK declares bankruptcy.
First, CHK would likely break its pipeline contracts. These contracts aren’t economical at this point. And while eventually new deals would be formed, that would take a while and in the meantime, CHK supplies of gas could be halted, driving up prices.
Second, CHK creditors would likely stop putting any non-critical capex into the firm’s wells. Many wells are going to be of questionable profitability and value at current prices, and putting any maintenance capex at all into some of them may simply be throwing good money after bad.
Third, CHK creditors could decide that asset sales at the company are likely to be stronger if they try and keep as many reserves in the ground as possible, opening up the opportunity for a buyer to capitalize on a price rebound in a year or two. Thus CHK creditors may look for ways to slow Chesapeake’s output – an action that would be illogical for equity holders and management, both of which have incentives right now to pump as much as possible in an effort to muddle through the current crisis.
None of these outcomes are guaranteed of course, and it is possible CHK may end up getting through the crisis on its own with no bankruptcy. But if they don’t, investors should be aware of the real possibility of a bankruptcy related price spike in U.S. Natural Gas.
By Michael McDonald of Oilprice.com
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