Chesapeake Posts Deep Losses On Write-Downs And Low Natural Gas Prices

Chesapeake Energy (NYSE:CHK), one of America’s largest natural gas producers, released its third quarter earnings on November 1. The company posted net loss of $2.1 billion compared to profit of $879 million in the same quarter last year due to write-downs relating to its natural gas assets. Low natural gas prices also caused revenues to tumble by around 25% despite a significant  increase in gas and liquids production. The company also announced that it will delay part of its asset sales planned for this year to 2013 as it was not able to realize prices as expected due to weak market conditions.

Liquids Offer Better Margins

Although natural gas prices showed a slight recovery this quarter with the company reporting an average selling price of $1.80 per mcf, this was still much lower than $3.40 per mcf realized last year. ^[1] To move to a relatively more stable revenue stream, the company is realigning resources to exploit liquid rich plays like oil for which prices have remained relatively stable. Liquids production grew by around 51% y-o-y to about 143,000 barrels per day. Of the total 89 rigs that the company currently operates, 79 are deployed for liquids exploration. The company says that is may be feasible to move resources back to gas production only if gas prices strengthen to about $5/mcf.

Asset Sales And Operational Improvements

The company has been tightening its spending by cutting capex and drilling outflows for the rest of the year. The firm, which was North America’s most active driller, has sharply cut down on new exploration, operating just 9 gas drilling rigs from a peak of over 80 rigs last year. In Q3, Chesapeake cut production costs by almost 14% to $0.84 per mcfe. ^[2] Given that liquids and gas production has been increasing, it is likely the company will see increasing economies of scale as well.

The firm grew rapidly from a small natural gas producer to a shale gas powerhouse backed largely by debt. With the falling prices and insufficient liquidity to pay debts, the company has been forced to sell several assets. It planned to sell $14 billion in natural gas and other assets by the end of this year. However, due to weak market conditions, it has not been able to realize prices as expected.

In Q3, Chesapeake sold a vast majority of its Permian basin gas fields for $3.3 billion, well below the $6 billion fair value pegged by several industry sources. The company also sold its pipeline business in September. Due to the weak pricing environment, the firm is being forced to postpone additional assets sales to 2013. To make up for any shortfall in expected cash, the company has raised money through a term loan of $2 billion. We believe that any further delay in asset monetization would highly impact the company.

A Recovery May Not Be Far Away

Since natural gas prices in the US continue to be low, many utility companies are choosing natural gas over coal for electricity generation. Natural gas offers lower emissions and natural gas power plants are becoming increasingly cheaper to construct. Heating demand for natural gas is also expected to be higher over the next two quarters in anticipation of a colder winter. Several industries like petrochemicals, that use natural gas as an input, are contemplating shifting plants to North America to take advantage of the low gas prices. In view of all these factors, we believe the demand for natural gas will increase going forward, bringing the markets closer to equilibrium, and consequently firming up prices.

We are currently updating our model for Chesapeake Energy following the earnings release.

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1. Chesapeake News Release [↩]
2. Chesapeake Energy Earnings Call Transcripts, Seeking Alpha [↩]