Chesapeake Cash Crunch to Widen Without Oilfield Sales

Slumping oil and natural-gas prices threaten to exacerbate a cash crunch at Chesapeake Energy Corp. (CHK), adding to pressure on Chief Executive Officer Aubrey McClendon to sell oilfields from Texas to Ohio.

Chesapeake relies on gas and its byproducts such as ethane for 90 percent of its production, and gas prices in the second quarter were down 46 percent from a year ago. That will probably force the company to lower its 2012 operating cash flow forecast, said Mark Hanson, an analyst at Morningstar Investment Services in Chicago.

McClendon has pledged to raise as much as $20.5 billion by the end of next year to fund drilling and maintain debt covenants. Without the sales, the cash-flow gap will widen to $18.6 billion by the end of 2013 and force Chesapeake to cancel drilling projects and reduce production targets, said James Sullivan, an analyst at Alembic Global Advisors in New York.

“They will get the asset sales done this year that they’ve promised to, but the question is 2013 -- where do they go from there after they’ve sold all the best stuff they had to offer?” Hanson said. “The leash will be much shorter and McClendon’s options much more limited.”

The Oklahoma City-based company is scheduled to announce second-quarter results after U.S. stock markets close today. Net income excluding one-time gains and losses is estimated by analysts to fall more than 80 percent to $99.6 million from $571 million a year earlier, based on data compiled by Bloomberg.

Leadership Shakeup

Chesapeake’s market value plunged to a three-year low in May as a glut-driven slump in gas prices squeezed the company’s cash flow and forced McClendon to accelerate the pace of asset sales. Gas prices have recovered from a 10-year intraday low of $1.902 in April, closing Aug. 3 at $2.877 per million British thermal units in New York. That’s still well below highs of more than $13 in 2008.

Investors have battered Chesapeake stock amid two federal probes of potential conflicts between the CEO’s personal financial transactions and corporate duties. McClendon, 53, was forced out as chairman in June and more than half the board was replaced as Chesapeake’s largest shareholders, Southeastern Asset Management Inc. and Carl Icahn, agitated for governance reforms.

McClendon also is losing access to a corporate perk that allowed him to buy personal stakes in almost every well the company drilled. The U.S. Internal Revenue Service and Securities and Exchange Commission are conducting inquiries.

Land Rush

Chesapeake fell 1 percent to $17.70 at the close in New York.

The company is selling oil- and gas-rich rock formations as major international explorers including Chevron Corp. (CVX) and Exxon Mobil Corp. (XOM) have amassed drilling rights in onshore U.S. prospects they previously ignored as marginal.

During the past decade, domestic explorers such as Devon Energy Corp. (DVN) and Chesapeake perfected intensive drilling techniques to crack shale formations, triggering a land rush from the Rocky Mountains to the Gulf Coast to Appalachia.

McClendon’s effort to shift Chesapeake’s production away from gas and more heavily toward oil and gas byproducts such as ethane and propane has been undercut by a growing glut of gas liquids from shale formations in Texas and Pennsylvania.

Ethane, a hydrocarbon that is stripped out of the gas stream before the fuel is pumped into pipelines, averaged 40 cents a gallon during the second quarter, 48 percent less than a year earlier. Ethane reached a 3-year high of 95 cents a gallon as recently as October, according to data compiled by Bloomberg.

Oilfield Demand

Demand for oilfields has been spurred as crude tripled to more than $95 a barrel in the past decade. West Texas Intermediate crude, the benchmark U.S. grade of oil, has averaged $98.83 a barrel this year, compared with $26.15 in 2002, according to data compiled by Bloomberg.

McClendon said in a March interview that the most-valuable asset he’s offered for sale this year, 1.5 million acres in the Permian Basin of Texas and New Mexico, may fetch at least $5 billion, or the equivalent of $3,333 an acre.

“The demand for oily plays such as the Permian is impacted by oil prices,” said Michael McMahon, managing director of the energy investment team at Pine Brook, a New York-based private- equity firm. “As long as oil is in the mid $80s or higher, there’s still a good profit to be made. Oil has to go to the low $70s for that region to become unattractive.”

‘Promising Areas’

The property probably won’t garner as high a price as the $7,000-an-acre Devon received last week for Permian stakes sold to Japan’s Sumitomo Corp. (8053) because the geology of Chesapeake’s holdings hasn’t been as extensively mapped as Devon’s, which makes it riskier to explore, Alembic Global’s Sullivan said.

The Permian Basin fields account for the equivalent of 332 billion cubic feet of Chesapeake’s proved reserves, Manuj Nikhanj, head of energy research at Investment Technology Group Inc. in Calgary, said in a July 10 note to clients. That would equate to about 11 percent of Chesapeake’s total proved reserves, based on U.S. Securities & Exchange Commission data.

Chesapeake’s Permian fields are “promising areas, but we have little data from Chesapeake about them,” Sullivan said.

McClendon considered quitting the Permian Basin once before, when he announced plans in September 2002 to pursue lower-cost prospects in the U.S. Midwest instead. Fifteen months later, he changed course with a $420 million acquisition including wells in the Permian from closely-held Concho Resources Inc. (CXO)

Mississippi Lime

McClendon also is counting on a cash infusion this year from a potential joint-venture agreement to develop a formation known as the Mississippi Lime in Oklahoma and Kansas.

Since 2009, Chesapeake has drilled 130 horizontal wells in the Mississippi Lime, where wells are half the cost of those in the Bakken shale of North Dakota and Montana, the company said in a July 16 presentation posted on its website. The company had 22 rigs operating in the Mississippi Lime as of last month.

Any deals announced today would be in addition to the $6.6 billion in transactions already signed this year.

(Chesapeake scheduled a conference call to discuss second- quarter results for 9 a.m. tomorrow. To access the call, go to www.chk.com.)

To contact the reporter on this story: Joe Carroll in Chicago at jcarroll8@bloomberg.net

To contact the editor responsible for this story: Susan Warren at susanwarren@bloomberg.net

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