Chesapeake Energy, the poster child of the US shale revolution and the so-called “Google of oil and gas” has voluntarily filed for Chapter 11 protection in the US Bankruptcy Court for the Southern District of Texas.
It’s a move the company hopes will help “strengthen its balance sheet and restructure its legacy contractual obligations to achieve a more sustainable capital structure,” but one that critics says underlines the problems with the shale oil revolution. i.e. the numbers don’t add up and it collapsed under the huge weight of its debts.
“It’s difficult to point to another company that has made more of a widespread impact on the US shale sector than Chesapeake,” said Alex Beeker, principal analyst on Wood Mackenzie’s corporate upstream team. “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.”
“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,” added Robert Clarke, vice president, US Lower 48 upstream.
“But – and it’s a big but,” warned Beeker, “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.”
Chesapeake Energy hopes to wipe out $US7 billion in debt through the restructuring process and has already secured $US925 million in debtor-in-possession financing in order to continue operations during the bankruptcy process.
“We are fundamentally resetting Chesapeake’s capital structure and business to address our legacy financial weaknesses and capitalize on our substantial operational strengths,” explained Doug Lawler, Chesapeake’s President and Chief Executive Officer.
“By eliminating approximately $7 billion of debt and addressing the legacy contractual obligations that have hindered our performance, we are positioning Chesapeake to capitalize on our diverse operating platform and proven track record of improving capital and operating efficiencies and technical excellence.
“With these demonstrated strengths, and the benefit of an appropriately sized capital structure, Chesapeake will be uniquely positioned to emerge from the Chapter 11 process as a stronger and more competitive enterprise.”
The move to file for bankruptcy protection has been a long time coming for the heavily indebted company but was accelerated by the drop in oil and gas prices caused by the global COVID-19 pandemic.
“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.”
According to Wood Mackenzie, “Chesapeake’s historical strength and business model had been exploration and organic leasing in the core of a play.” After an acreage of potential shale gas has been proven viable, Chesapeake would then sell it at a premium to a company which would then fully develop the acreage. Chesapeake, on the other hand, would then take that money and move on to the next play.
“This model has netted Chesapeake US$50 billion in asset sales since 2000 – a truly staggering figure,” Beeker explained. “However, it came to a screeching halt with the commodity price crash and subsequent freeze in the M&A market.”
“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,” added Clarke. 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.”
However, as far back as November 2019 there were rumours that Chesapeake was close to selling some of its shale assets in Haynesville, Louisiana, having already dropped the last two active rigs in the basin in the preceding September, “a sure sign a company is trying to exit,” according to Beeker.
“Ultimately the deal never got done. $US1 billion would have gone a long way towards extending the company’s runway, but it may not have been enough.”
“If I were to describe Chesapeake in one word, that word is ‘excess’ – excess liabilities, excess costs, excess gas in an oversupplied market,” concluded Clarke. “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.”
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