Why Chesapeake Is Doing Even Worse Than Oil and Gas Peers

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It has been a little over two years since Aubrey McClendon said farewell to Chesapeake Energy Corp. (NYSE: CHK), the company he co-founded and of which he was once chairman and CEO. Chesapeake’s stock closed at just over $19 a share on the day of the announcement, up 6%. On Friday, shares closed at just over $14 a share, a decline of 26%.

Without McClendon to blame any longer, Chesapeake is among the worst performers on the S&P 500 index so far in 2015, down 29%. Until the company reported fourth-quarter and full-year earnings in late February, shares were trading roughly in line with the S&P 500.

The big problem for Chesapeake, and every other oil and gas producer, has been the dramatic collapse in oil and gas prices. West Texas Intermediate (WTI) crude oil traded at around $55 a barrel at the beginning of the year and has now fallen to around $48 a barrel. Natural gas traded near $3 per million BTUs and has dropped to $2.65.

How bad is that? Chesapeake’s average realized price per barrel of crude in the fourth quarter was $76.40. Crude has not topped $57 a barrel so far this year.

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Chesapeake’s average realized price for natural gas in the fourth quarter was $1.72. That should improve somewhat in the first quarter of this year, and because natural gas accounts for more than two-thirds of Chesapeake’s production, that will help boost revenues.

But as a percentage of total sales, natural gas sales (including hedging impact) accounted for about 38% of the total. Oil sales, including the impact of hedges, accounted for about 43% of total hydrocarbon sales. Slicing the per barrel price of crude by more than $15 a barrel will have a disproportionate impact on Chesapeake’s revenues.

The company plans to focus more than half its 2015 capital spending budget on drilling and completion in the Eagle Ford shale play in south Texas and the Utica shale play in eastern Ohio. Each produces about 100,000 net barrels of oil equivalent per day, with Eagle Ford production weighted toward liquids production and Utica production almost all natural gas.

Chesapeake continues to sell assets and to work down its remaining $11 billion in long-term debt. In late December the company sold assets in the Marcellus shale play for about $5 billion to Southwestern Energy Co. (NYSE: SWN). On the same day, Chesapeake announced a $1 billion share buyback plan.

About 75% of Chesapeake’s proved reserve balance of approximately 2.5 billion barrels of oil equivalent at the end of 2014 is developed, and the proved reserves rate of growth, including the impacts of sales and acquisitions, was -8%. If a company cannot, for whatever reason, at least add as much new proved reserves in a year as it extracts, that is a warning sign to investors.

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So Chesapeake is between a rock and hard place. It needs to sell assets to help it reduce its debt, but it needs the assets to replace extracted reserves. The price of crude has a large impact on the company’s sales, and while the price of crude remains low, Chesapeake is not getting any help to increase its exploration for more reserves. Add to that the need to continue to pay dividends and buy back stock, and Chesapeake’s troubles come into sharper focus.

Shares traded down about 0.8% in the noon hour on Monday, at $13.91 in a 52-week range of $13.38 to $29.92. The consensus price target on the stock is $18.84.