Chesapeake Energy Corporation (CHK), an iconic oil and gas exploration and production company, has seen its shares fall more than 90% over the past year. With the collapse in crude oil prices, the stock is the latest casualty in a growing war between Saudi Arabian and American oil interests. This drop was driven by over $15 billion in impairments on its properties during the first nine months of 2015, resulting in CHK suspending its preferred stock dividend.
While the stock is still valued at just over $1 billion, investors have become increasingly skeptical about its ability to emerge from the chaos intact. The company’s $10 billion + in long-term debt could become problematic to service with diminishing cash flows. This likely was the deciding factor in hiring a team of restructuring advisors in late 2015. As such, fourth-quarter earnings on February 24 will be closely eyed by investors in the space.
Breakeven Points
Chesapeake’s problems stem from its crude oil breakeven point of about $45 per share, which is significantly lower than the current price of about $30 per barrel. While the company may have hedges in place to raise its selling price to a certain extent, these are temporary measures rather than a long-term solution. The only near-term solution is to cut costs to try and weather the storm until the supply glut works through the system and prices recover.
Chesapeake isn’t in the minority when it comes to being underwater on crude oil margins. Conventional deep-water rigs are among the only sources of domestic crude oil that are actually generating a profit right now, with the costs of conventional and unconventional onshore oil more than $60 per barrel. Many producers have hedges in place for now, but the future remains largely uncertain.
Cost of Leverage
Chesapeake cannot simply turn off production in wells where it’s losing money because it needs the cash flow to pay off its $10.7 billion in long-term debt. Without restructuring these debts, they will ultimately catch up to the company and force a liquidity crisis. Linn Energy LLC (LINE) recently went through just that. CHK holds a large amount of debt that many experts believe will force it into bankruptcy in the near-term.
The high leverage employed by Chesapeake isn’t out-of-the-ordinary in the oil industry. After crude oil prices soared, many producers rushed to finance high-cost, unconventional drilling projects, accruing a lot of debt in the process. Standard & Poor’s warned that roughly half of energy junk bonds are “distressed,” while nearly one-third of 2015’s defaults came from oil, gas, or energy companies that were unable to make debt service payments.
The Bottom Line
The precipitous fall in crude oil prices has claimed a number of victims, and Chesapeake is only the latest company to struggle. While many of these companies have short-term measures to stem the losses, the long-term economics paint a bearish picture. The combination of high breakeven points and excessive leverage has created a liquidity strain that could take a toll on a number of energy companies operating in the oil and gas space.
