Chesapeake Energy – shale’s great disruptor – files for Chapter 11
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Speaking after Chesapeake Energy filed for Chapter 11 bankruptcy protection today, Alex Beeker, principal analyst on Wood Mackenzie’s corporate upstream team, said: “It’s difficult to point to another company that has made more of a widespread impact on the US shale sector than Chesapeake.
“The tech sector dubs companies or people that shake up that status quo as disruptors. For the US shale sector, there was been no bigger disruptor than Chesapeake.
“Chesapeake showed the market – and its competitors – how quickly production could grow, how fast projects could develop, and what the updated US model for engaging with stakeholders looked like. Remember they brought international upstream investors back to US onshore.”
'Google of oil and gas
Robert Clarke, vice president, US Lower 48 upstream, added: “At the first analyst day Chesapeake held, I overheard hedge fund analysts saying: ‘What is this place? The Google of oil and gas?’ And, yes, in a way, it was.”
Beeker said, based purely on its asset base, the company is attractive.
“But - and it’s a big but - it’s hard to make any upstream assets look good with nearly $1 billion in interest and G&A expenses per year. Add more than $1 billion in midstream gathering and transportation contracts per year to that, and it’s a no-win situation.”
Half-cycle, Chesapeake’s southern Eagle Ford assets breakeven at US$40/bbl in our models. The Powder River basin and the Brazos Valley acreage break even closer to US$50/bbl, both represent oil growth potential should oil prices recover.
Clarke added that about 40% of the company’s revenue came from gas and natural gas liquids last year. The relative stability of gas prices in 2020 – and even forecast strength in 2021 compared to oil – is one thing that differentiates Chesapeake from some of its peers. The Marcellus holdings offset some of the basin’s best producers and could have real strength.
Long time coming
“This filing has been a long time coming,” Beeker said. “It was likely going to happen with or without Covid-19.
“Chesapeake refinanced debt at an interest rate above 10% in December 2019. The term loan facility included some aggressive covenant provisions, including a quarterly step-down in the net debt-to-EBITDA ratio.
"The company was forced to make some difficult decisions, notably whether or not to keep drilling unprofitable wells to support EBITDA just to avoid breaching debt covenants.”
Chesapeake’s historical strength and business model had been exploration and organic leasing in the core of a play.
After acreage had been proven viable, Chesapeake would sell it at a premium to a company that would come in to fully develop the acreage. It would then take that money and move on to the next play.
Beeker said: “This model has netted Chesapeake US$50 billion in asset sales since 2000 – a truly staggering figure. However, it came to a screeching halt with the commodity price crash and subsequent freeze in the M&A market.”
Clarke added: “Chesapeake was built on a few core principles: gas prices would be stay over $6 per million cubic feet (mcf) for the long term, and the company could identify and delineate plays faster than anyone else. This is where Chesapeake captured value.
“They then recognised that value early by selling down interest - just like successful conventional explorers - or by bringing in partners to carry development costs.
“There was talk of bankruptcy about six years ago, after the last Henry Hub spike in 2014. It didn’t carry much weight then because Chesapeake had millions of acres in proven plays that could be divested.
"And while the company has a history of being leveraged, to investors it the earlier days it did not appear dangerously so, particularly if the gas price floor was $6/mcf and debt was funded at sub-4% rates.”
Beeker said the position changed once the deal flow for gas properties froze. Chesapeake was unable to trim its portfolio and carried too much debt after the 2015 crash.
“New management teams have been in triage mode to sell assets and shift towards a more oil weighted company. Their efforts, while valiant, were too little, too late,” he said.
Too little, too late
“In November 2019, there were rumors Chesapeake was close to selling its Haynesville assets for US$1 billion - it had dropped its last two active rigs in the basin in Sept 2019, a sure sign a company is trying to exit.
"Ultimately the deal never got done. US$1 billion would have gone a long way towards extending the company’s runway, but it may not have been enough.”
Clarke said: “One point worth considering is that Chesapeake’s early bet on shale technology proved to be largely correct.
“The company was asked to grow into the forward curve and it did. Chesapeake’s equity performed very well against its peers when gas prices supported its business model. This real issue was an inability to adapt.”
He added: “If I were to describe Chesapeake in one word, that word is ‘excess’ - excess liabilities, excess costs, excess gas in an oversupplied market.
"But when excess was good, they had it too. Excess exploration upside, excess acreage, excess production growth, excess partnerships.
“To me, they’re a story of extremes. But a gas downturn this long means that excess risk has to run its course.”