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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Chesapeake Has Bought Itself Time But Can It Survive?

Chesapeake Has Bought Itself Time But Can It Survive?

The last year has been a bumpy one for Chesapeake Energy. When natural gas prices collapsed several years ago, many firms across the industry moved towards liquids as a panacea. The same group of execs that tanked the natural gas markets in the U.S. through over production went on to overproduce in shale, resulting in the current morass. It is little wonder then that firms like Chesapeake have had little refuge from the chaos in recent quarters. CHK reported a $2.2 billion loss in its most recent quarter, reflecting the market carnage.

After a collapse of 90 percent in the 12 months ending in February, the stock bottomed at $1.50 a share. Since that time, CHK has rallied more than 400 percent, closing close to $7.00 a share by late April. While the company has been humbled, the stock still sports a market capitalization of more than $4 billion. Longer-term solvency issues remain a potential issue given CHK’s $9.5 billion debt balance, but for now the company has created an effective liquidity runway, which should help the stock survive the market turmoil.

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A critical part of Chesapeake’s success in the last couple of months is the renewal of its $4 billion credit base in the Spring redetermination period. That agreement did not come cheap or easily though, as the company has had to pledge all of its assets, including adding mortgages that encumber roughly 90 percent of its proved oil and gas reserves. Still with the next review of the firm’s credit facility postponed for more than a year until June 2017, the company has certainly bought itself time to ride out the low commodity price environment. Analysts have started turning more positive on the stock as well and that has helped boost equity values creating a virtuous cycle. Related: Can This Pipeline Unlock East-African Oil Potential?

Despite these positives, Chesapeake’s stock may not have a lot more upside from here for now unless oil prices continue to move higher. It still faces short-term challenges related to commodity supply overhang and the resulting depressed pricing environment in both oil and natural gas. The firm did get $385 million in much needed cash thanks to the Western Anadarko Basin divestiture, which has helped support the repurchasing of senior notes. The company averaged production of roughly 680,000 barrels of oil equivalent per day in 2015, which was up 8 percent versus 2014 (after adjusting for asset sales). That growth is not sustainable in the current environment, and it’s very unclear if new production activities at the firm will be profitable until a substantial commodity price increase ensues.

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Chesapeake has guided 2016 production down by between 0 and 5 percent versus 2015 levels based on a capex budget of $1.3 to $1.8 billion (down 57 percent versus 2015). Of that budget, the vast majority – around 70 percent - is to be put towards completions. All of this is consistent with a pricing environment that is not profitable for new production projects despite well efficiency improvements and reduced services costs around a more efficient supply chain. While CHK is far less dependent on oil than most O&G firms, with just 25 percent of 2016 production likely to come from liquids, the company is still exposed to the same problems that are plaguing the rest of the industry.

Natural gas prices should move somewhat higher over the course of the year, potentially averaging $2.50 per mm Btu. That will help Chesapeake, but not enough to return the stock to its former glory days. For now, the concerns around a CHK bankruptcy have subsided and provided the most loyal investors with a spectacular comeback since February. The longer-term outlook remains tough though, so it is unlikely that CHK can repeat its performance from here.

By Michael McDonald of Oilprice.com

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