Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Here's a trick question: How much is Chesapeake Energy worth?

To which a fair response might be: "Duh, don't you write for Bloomberg? Type in "CHK US Equity DES <GO>". And indeed, the market cap is right there: $4.1 billion.

But when you're carrying as much debt as Chesapeake does and depend, like Chesapeake, on the fickle gods of oil and gas for your income, market cap isn't even half the answer. Add in the company's net debt -- along with preferred equity and minorities -- and its enterprise value, reflecting the entire capital structure, soars to almost $16 billion.

 

Even that doesn't truly capture it, though, because that figure uses the principal balance of Chesapeake's debts, and they don't tend to trade at 100 cents on the dollar. For example, its biggest outstanding bond -- $2.4 billion of 8 percent notes due in 2022 -- trade around 90 cents. Those par amounts are real obligations, of course, but as I wrote here, Chesapeake has been doing what it can to take advantage of those lower prices to take out some debt on the cheap.

Chesapeake, though, would prefer you focus on another measure entirely, one that goes by the name of "PV-9 – June 30, 2016 @ NYMEX Strip". Not terribly catchy, granted, but this $11.9 billion figure is the center of Chesapeake's highly leveraged world right now.

What that number represents is a projected cash flow valuation of Chesapeake's proved oil and gas reserves using futures prices (that's the "NYMEX Strip") as of June 30, discounted to a present value at a 9 percent rate ("PV-9").

Under SEC rules, oil and gas companies publish this sort of analysis at the back of their annual 10-K filings. However, those are done using a 10 percent discount rate and, more importantly, are based on trailing oil and gas prices. As you can see below, that makes a big difference.

Name Your Price
Chesapeake Energy's valuation is a moving target
Source: Bloomberg, the company.
Note: Market cap and enterprise value represent company valuations for Chesapeake. PV-9/10 metrics reflect discounted cash flow valuations of Chesapeake's proved oil and gas reserves.

As James Sullivan of Alembic Global Advisors points out, futures prices are generally higher than trailing prices. The upward sloping futures curve -- "contango" in trading parlance -- is a reflection of the glut in physical oil and gas weighing on prices for immediate delivery and an incentive to store surplus supply. Here's how they compare (natural gas first):

Bright Future
Gas futures are 40 percent higher on average than trailing prices
Source: Bloomberg
Note: Historical prices as per the first trading day of each month. Futures prices as at June 30, 2016.

And then oil:

Heaven '17
Crude oil futures were 19 percent higher than the trailing average at the end of June
Source: Bloomberg
Note: Historical prices as per the first trading day of each month. Futures prices as at June 30, 2016.

No one buys oil and gas stocks based on trailing prices.

Then again, equity investors aren't the main audience for Chesapeake's alternative valuation measure anyway. The $11.9 billion figure -- which, you'll notice, isn't far off the enterprise value -- is aimed squarely at lenders, on whose good graces Chesapeake relies heavily while it negotiates the downturn.

At the end of June, it had just $4 million of cash on its balance sheet, down from $825 million at the end of 2015. A $4 billion revolver agreed with banks in April is a lifeline, so Chesapeake has good reason to show the value of its reserves, or "collateral," in as favorable a light as possible.

And with oil and gas futures for the next 12 months having retreated since the end of June -- down 14 percent in oil's case -- and a lot of walking wounded in the E&P sector, Chesapeake isn't alone in that regard.

Correction: Chesapeake's enterprise value is almost $16 billion. An earlier version of this story incorrectly said it was almost $12.8 billion.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net