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Investment Overview for Chesapeake (NYSE:CHK)
WHAT HAS CHANGED?
- Four Point Strategy To Weather The Downturn
The ongoing commodity slump has severely impacted the revenue and earnings of oil and gas producers, such as Chesapeake Energy. As a result, the second largest natural gas producer has developed a four point strategy to weather the current down cycle. The strategy would entail:
- Maximizing liquidity - The company aims to reduce its capital budget by more than 50% to preserve its depleting cash flows. For the full year, the company expects to spend $1.26-$1.76 billion on its exploration and drilling activities. Further, the company aims to reduce its operating costs significantly to maintain its operating margins. For example, the company expects to reduce is lease operating expense (LOE) and general and administrative (G&A) expense by 10% and 15% respectively during the year.
In the June quarter, Chesapeake managed to reduce its cash costs by 25% on a year-on-year basis and is on track to achieve its target for the year.
- Optimizing portfolio - Given the paucity of cash to finance its capital spending program, Chesapeake has been resorting to divestitures. In this quest, the company exited its interest in Barnett Shale play during the second quarter. At the end of the first half of 2016, the company had completed asset sales of $1 billion and is expected to generate more than $2 billion in asset divestitures by the end of the year, which is higher than its previous target of $1.2-$1.7 billion. The company has also acquired ~70,000 net acres in the Haynesville play.
- Increasing cash flows - In order to improve its EBITDA, and, in turn, the cash flows, Chesapeake is consistently negotiating better terms for its gathering and transportation agreements. In the June quarter, Chesapeake renegotiated Mid-Continent gathering agreements, resulting in a reduction of 36% in its gathering costs. These renegotiations are likely to lead to an EBITDA uplift of $200 and $300 million in 2016 and 2017 respectively.
- Improving Capital Structure - The oil boom had resulted in a huge debt on Chesapeake's balance sheet. However, in order to save itself from bankruptcy, the company has been actively refinancing its debt due within the next two years at lower rates. Overall, the company has reduced debt obligations of ~$830 million since September 2015, which is likely to provide incremental liquidity of roughly $730 million. Further, the company has secured a term loan of $1.5 billion and has managed to negotiate favorable covenants such as interest coverage ratio and leverage ratio through 2017.
Below are some key value drivers for Chesapeake that present opportunities for a significant upside or downside to the current Trefis price estimate for the company:
- Crude Oil & NGLs Average Sales Price: Chesapeake's stock price is highly sensitive to crude oil and natural gas liquids prices as the company derives almost 60% of its total value, by our estimates, from the sale of these commodities. We believe that the recent decline in oil prices could sustain for a longer period, amid slower demand growth and the diminishing price-controlling power of the OPEC. According to our estimates, the annual average Brent crude oil price is expected to remain weak for the next couple of years, before recovering back to $95 per barrel over the long term. However, if oil prices remain depressed for longer than what we currently expect, and only reach $80 per barrel by the end of our forecast period, there could be a downside of more than 16% to our current price estimate for Chesapeake.
- Crude Oil & NGLs Net Production: Chesapeake's crude oil and natural gas liquids production has grown sharply from just around 32 million barrels in 2011 to 75 million barrels in 2014, implying a CAGR of almost 33%. However, due to the ongoing commodity down cycle, Chesapeake's net liquids production declined to 70 million barrels in 2015. Based on our forecast for crude oil prices, we expect the production to improve gradually to 85 million by the end of our forecast period.
However, if the company is not able to ramp up its crude oil and natural gas liquids production at the projected rate, and it stands at 79 million barrels by the end of the Trefis forecast period, there could be a 16% downside to our current price estimate for Chesapeake. On the other hand, if the company is able to grow its net liquids production to about 90 million barrels, there could be a 14% upside to our current price estimate for Chesapeake.
For additional details, select a driver above or select a division from the interactive Trefis split for Chesapeake at the top of the page.
Chesapeake Energy is the 2nd-largest producer of natural gas and the 13th-largest producer of liquids in the United States. The company is also one of the most active drillers of new wells in the U.S. The company's operations are focused on discovering and developing unconventional natural gas and oil fields onshore in the U.S. It owns positions in the Barnett, Fayetteville, Haynesville, Marcellus, and Bossier natural gas shale plays, and in the Eagle Ford, Granite Wash, Niobrara, and various other conventional and unconventional liquid-rich plays across the U.S. The firm has interests in over 37,100 natural gas and crude oil wells that produce approximately 672 thousand barrels of oil equivalent per day.
The natural gas assets that the company built over the years are very lucrative. However, of late, the company's operations have taken a beating due to relatively low natural gas prices. As a result, it has shifted its focus towards crude oil and natural gas liquids, spending heavily on building liquid-rich or oil assets.
Large base of proven reserves
Proved reserves is an extremely critical metric for an oil and gas exploration and production company. It represents the total quantity of technically and economically recoverable oil and gas reserves owned by the company at a given point in time. It directly impacts the company's production growth outlook.
Chesapeake's proved hydrocarbon reserves stood at 1.5 billion barrels of oil equivalent at the end of 2015. The metric decreased by 965 million barrels of oil equivalent, compared to 2014, primarily because of the downward revision of previous reserve estimates and the sale of reserves in place. Despite that, Chesapeake currently holds enough reserves to produce oil and gas for the next 6 years at 2015 production rates.
Chesapeake's net production volume-mix has been improving over the past few years with the proportion of liquids in its total oil equivalent production increasing. Liquids are generally priced higher than dry natural gas due to higher energy density and ease of transportation, among other factors. In addition, severely depressed natural gas prices in the U.S., primarily due to a supply glut, have further eroded the incentive for upstream oil and gas companies to drill for dry gas. In 2015, Chesapeake sold liquids at an average price of over $18 per barrel, while the company realized a price of just around $8 per BOE for natural gas on average.
Therefore, despite lower finding, development, and lifting costs per BOE of natural gas, the production of liquids is still a far more lucrative source of revenue for upstream oil and gas companies in the U.S. The proportion of liquids in Chesapeake's total production volume-mix has improved significantly from just around 16.1% in 2011 to 28.2% in 2015. We expect the company’s sales volume-mix to improve further as it plans to increase its focus on liquids production in the coming years.
Production decline due to asset sales
Chesapeake sold certain assets in the southern Marcellus Shale and a portion of the eastern Utica Shale to a subsidiary of Southwestern Energy Company for aggregate net proceeds of approximately $4.975 billion in 2014. The company sold approximately 413,000 net acres of property and approximately 1,500 wells in northern West Virginia and southern Pennsylvania, of which 435 wells are in the Marcellus or Utica formations, along with related gathering assets and property, plant and equipment. In addition, the company's subsidiary CHK C-T sold all its oil and gas reserves to FourPoint and used the consideration, plus other cash it had on hand, to repurchase and cancel all of CHK C-T’s outstanding preferred shares.
This negatively impacted Chesapeake's net liquids production in 2015. The company's net crude oil and natural gas liquids production was around 70 million barrels in 2015, down from 75 million barrels in 2014. The transaction also lowered its long-term growth potential as it resulted in a reduction of its proved undeveloped hydrocarbon reserves by around 363 million barrels or 60% of the starting figure in 2015.
It is estimated that a large part of the world's oil reserves have already been discovered. Recent statistics have indicated that global consumption has been outpacing reserve additions. Peak oil is a commonly used term to describe the point at which world oil output will reach a maximum and decline afterward.
However, many institutions such as the International Energy Agency (IEA) believe that peak oil will not occur for another 25 years at the very least. Many governments across the world are promoting alternative energy measures to ensure that the supply and demand of energy will be met at all times to come.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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