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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for Oilprice.com with over a decade of experience writing for news outlets such as iNVEZZ and SeeNews. 

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This U.S. Shale Giant Is On The Brink Of Collapse

One of the shale gas pioneer companies in the United States said earlier this month that depressed oil and natural gas prices may force it to breach loan covenants over the next year and that a massive debt pile threatens its ability to “continue as a going concern.”

Chesapeake Energy—which helped propel the shale gas revolution in the late 2000s with leading positions in the Marcellus, Barnett, and Haynesville shale basins—is now facing tough times trying to heal its balance sheet, on which US$9.7 billion in total debt weighs.

The company is looking to improve its balance sheet and is evaluating multiple options to reduce debt and to become, finally, free cash flow positive next year.  

Chesapeake Energy’s troubles are indicative of the current woes of the whole U.S. shale patch—firms now have to focus on generating free cash flow and successfully manage the debt they had taken on to boost production instead of profits. Squeezed between the scarce availability of capital from debt and equity markets and investors demanding more profits, many U.S. oil and gas firms are reducing capital expenditure plans for 2020.

Producers are also cutting production targets and now admit that the fast-paced growth of the past two years will slow down to moderate growth over the next few years. 

In this challenging environment, aggravated by low commodity prices, Chesapeake Energy warned in early November that “If continued depressed prices persist, combined with the scheduled reductions in the leverage ratio covenant, our ability to comply with the leverage ratio covenant during the next 12 months will be adversely affected which raises substantial doubt about our ability to continue as a going concern.” Related: All Eyes On China As Oil Demand Dwindles

The stock took a dive and has now lost nearly 60 percent in less than a month, and during this time it also touched a 25-year-low. Year to date, Chesapeake Energy’s shares have lost 72 percent.  

Yet, the company and some analysts believe that Chesapeake Energy is not dead yet and will not die.

According to Matthew DiLallo, senior energy and materials specialist with The Motley Fool, Chesapeake’s reduced spending next year, reduced natural gas production, and the strive for free cash flow could help it to avoid default.

Due to lower oil and gas prices, Chesapeake is slashing its 2020 capital expenditure forecast by around 30 percent, and expects to reduce 2020 production by some 10 percent.  

“We will continue directing the majority of our -- capital to our highest margin oil assets and our capital spend will be ultimately be determined by commodity prices in 2020,” Chesapeake’s President and CEO Doug Lawler said on the Q3 earnings call.

The reduction in cash costs will allow the company to target free cash flow in 2020, he said, adding that Chesapeake is assessing multiple ways to bolster its balance sheet.

“We continue to evaluate multiple opportunities that can further improve our balance sheet, including divestitures, deleveraging acquisitions and capital funding options,” Lawler said.  

Chesapeake Energy is reportedly in talks with leading Haynesville basin producer Comstock Resources to sell its Haynesville assets in Louisiana, in a deal that could be valued at more than US$1 billion. If the deal goes through, this could be one strategic divestiture to raise some cash and reduce the debt pile. Related: How To Invest In An Oil Contango

A week after Chesapeake warned of its distressed situation, Morgan Stanley said it expects the firm to be able to manage debt and avoid default.

“While we expect the company to successfully manage through the potential covenant breach in 2020, it will likely require strategic action and/or waivers,” Morgan Stanley said, as carried by MarketWatch.  

Scotiabank also expects Chesapeake to successfully manage debt, via a combination of asset sales and consolidation of Brazos Valley operations.

Last week, Moody’s cut its ratings on Chesapeake, with Moody’s Senior Analyst John Thieroff motivating the move:

“The downgrades reflect the heightened potential for Chesapeake to undertake a distressed exchange or other restructuring activity in light of the company’s history of largescale purchases of its debt at distressed levels, the deep discount at which its debt is trading and statements the company’s management has made pointing to the possibility of 'capital exchange transactions'.”

However, Chesapeake has large positions in major shale plays, which give the company operating scale efficiencies and the potential to sell assets in order to cut debt, Moody’s said.  

By Tsvetana Paraskova for Oilprice.com

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  • Mamdouh Salameh on November 28 2019 said:
    The financial troubles facing Chesapeake Energy, one of US shale oil production pioneers and the continued decline in oil rig count are symptomatic of a general malaise afflicting the whole US shale and gas industry.

    It is an industry which has been unprofitable since its emergence in 2008. It is an industry built on a unique business model, namely robbing Peter to pay Paul. If it was judged by the standard business criteria by which other successful companies are judged, it would have been declared bankrupt years ago.

    A pivotal principle in business is to aim for business opportunities that maximize the return on capital. Another equally pivotal principle is to drop unprofitable business in order to cut losses.

    The Achilles heel of US shale oil production is the high depletion rate ranging from 70%-90% in the first year of production necessitating the drilling of more than 10,000 new wells at an estimated cost of $50 bn a year not only to maintain production but at current times to decelerate the continuous slowdown in shale oil production.

    Even giant oil companies like ExxonMobil and Chevron with deep pockets to sustain a financial bleeding at shale oil plays, will realize sooner or later that their most rational policy is to cut their losses and use their capital in outlets around the world where they can maximize their return on capital.

    Yet, the US Energy Information Administration (EIA), the International Energy Agency (IEA) and Rystad Energy continue hyping about the rising production of US shale oil.

    Rystad Energy takes the top prize of hyping by claiming that US oil production will hit 18 million barrels a day (mbd) by 2030.

    The US shale oil industry will be no more in 5-10 years.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Rick Rod on November 28 2019 said:
    Shale is not profitable at $55 a barrel no matter how much or little is produced. Good timing though, selling assets at a time when capital restraints are biting across the surviving shale companies. I am not sure Chesapeake is a ponzi scheme but it does not exist to create a profit for its investors (like 90% of the shale oil companies).

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