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Chesapeake peers over the precipice

Rapid expansion beyond core natural gas assets has stretched the firm to the verge of bankruptcy

The US shale sector may be able to take a deep breath after months of ruinously low oil prices, as the unprecedented drop in global energy demand was compounded by a domestic storage crisis. The gradual easing of economic restrictions and swingeing output cuts have lifted WTI above $40/bl, barely two months after futures contracts plunged into negative territory for the first time in history.

But for US independent Chesapeake Energy the welcome news risks being too little, too late. The firm is on the brink of bankruptcy following missed payments that were due on 15 June and the loss of $700mn in available credit. Chesapeake has just 30 days to avoid default before becoming the most high-profile shale casualty.

Conditions were already challenging for Chesapeake before the Covid-19 pandemic. The company’s total debt had grown to over $9bn off the back of an aggressive production growth strategy, a practice imitated by many during the first shale boom before capital discipline became the new industry slogan.

“We do not expect widespread M&A activity among independents in the US shale patch” Cacanando, Odeon Capital Group

In 2019, Chesapeake added 420,000 net acres of new acreage and 47,000bl/d oe in production to its portfolio following its $4bn swoop for Texas shale producer Wildhorse Resources. The acquisition consolidated the firm’s position in the Eagle Ford basin—part of a portfolio drive that increased its operating footprint into five states and six basins and had grown crude production by 30pc year-on-year in 2019—but snowballed its debt burden at an unsustainable pace.  

Barely 10 months after the merger was announced, Chesapeake’s cash pile had fallen to less than $10mn and the company declared a threat to its ability to continue as a ‘going concern’. Chesapeake posted a $308mn net loss in 2019, and despite reducing its debt burden by a very material $900mn, faced over $300mn in looming debt maturities heading into 2020.  

From bad to worse

Chesapeake had guided flat production for 2020, before the Covid-19 outbreak, reducing capex by 30pc. And while the ambition was almost achieved, with output falling just 1pc in Q1 year-on-year, crumbling oil prices since have intensified the financial pressure on the producer. 

The firm’s realised oil prices sunk by 27pc across all basins in Q1, with the Marcellus and Haynesville plays the most severely impacted, seeing declines of over 40pc. Chesapeake’s breakeven is $35-45/bl, making much of its production uneconomic until recently.

$9bn – Debt maturities due

Investors soon started to grasp the scale of the problems. Chesapeake’s share price collapsed by over 90pc as the hefty debt started to weigh. In April, the board was forced to carry out a reverse-stock split to stabilise the decline. The company’s finances became so precarious that the Q1 earnings call was cancelled and crude production cut back by 50pc in May and a further 37pc in June.

Financial results would have been even worse if not for prudent hedging. Production revenues halved during Q1 compared with the same period the previous year, despite 76pc of oil and 53pc of gas being hedged. Many shale producers adopted the same strategy last year when volatile prices looked likely to remain into 2020. But Chesapeake has little protection going into next year even if it somehow manages to stave off bankruptcy.  

Desperate times

Divestment had been the firm’s ‘Hail Mary’ option. Chesapeake initially planned to offload $300-500mn in non-core assets to help meet its debt obligations. But the rapid collapse of oil prices and global energy demand have slashed asset values and investor interest. “We do not expect widespread M&A activity among independents in the US shale patch given that potential buyers are also struggling,” says Hillary Cacanando, senior vice president, equity and fixed income research, at US bank Odeon Capital Group.

As the firm flirts ever closer with bankruptcy, its only option may be to offload assets at budget prices. And if Chesapeake does default on its debts it will have implications for the US midstream sector. The company is the fifth-largest gas producer in the US, and bankruptcy would raise serious doubts over its ability to honour contracts for capacity with pipeline operators.

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