by Kathleen Martin
A recent report has worldwide natural gas consumption rising 17% by the year 2017. The report states that the reason for the rise in consumption is that demand in the U.S. and China will surge in the next five years. For now the technological advances that have made extraction of shale gas so cheap and easy is the major reason that the commodity is trading near decade lows, with supply far outpacing demand. Companies such as Apache (APA), Exxon Mobil (XOM) and SandRidge (SD) will benefit from the increased consumption of natural gas. Is the potential for increased consumption enough to pull the shares of traditional energy companies out of the basement?
Of even greater concern is the fact that Chesapeake (CHK) has to sell $7 billion in assets this year in order to be on the right side of its debt obligations. This is problematic as the company's cash flow has been hurt by the price of domestic natural gas. The company has a $10 billion funding short-fall. Chesapeake needs to sell $7 billion in assets to meet its debt agreement covenants. Low natural gas prices have now caused Chesapeake to be dependent on asset sales to fund capital expenditures needed to put the company in a position to have higher yielding liquids production.
The company closed its natural gas hedge program in 2011, making it vulnerable to the recent decade lows of natural gas prices. Any further decline in natural gas and crude prices will reduce the value of Chesapeake's assets which will in turn diminish any returns on asset sales. As Chesapeake is in the business of oil and gas exploration, development and production, all of Chesapeake's assets are exposed to the risks of capital market conditions, the eurozone difficulties and other global macro-economic factors. Chesapeake will be looking for some forbearance from its credit providers to weather this tough market. Chesapeake has sold $7 billion in assets in 2010 and $10 billion in 2011 to improve its cash position.
The company announced that it will sell approximately 338,000 acres in the Ohio Utica shale formation in order to meet its debt obligations. The acres have five non-operated wells and two operated wells. It also includes exploration properties which are at the feasibility stage right now. One of Ohio's wells produced two percent of Ohio's natural gas yield last year. The sale is expected to close on August 7, 2012.
Chesapeake announced a discovery in the Anadarko Basin along the Texas and Oklahoma border, where it owns approximately 30,000 acres. The company's CEO, Aubrey McClendon expects that the new discovery will provide a lift to Chesapeake's program of concentrating on the company's existing assets to provide growth and value for shareholders rather than looking to new acquisitions to do so. The find will further add to the company's growing liquids production which will have a positive effect on the company's performance in the future. The company plans to drill 65 more wells in the Anadarko Basin.
The borrowing habits of the CEO, Aubrey McClendon and the potential conflict of interest created by his managing a hedge fund that traded in energy while the CEO of Chesapeake, have come back to haunt the stock. Aubrey McClendon used his ownership in the company's wells as collateral for a loan from a company that Chesapeake was doing business with.
Investors understandably didn't like this. The short players are waiting for some indication that the company can put the past behind it and carry on managing the company's production assets. The company had to acquiesce to its two major shareholders and replace four board members with non-management directors. One of the shareholders, Carl Ichan, who owns 7% of the company's shares, indicated that the board was willing to grant the shareholders a voice by responding to pressure to change the makeup of the board. Aubrey McClendon remains at the helm, although he may step aside as he has previously indicated he will, if a suitable successor is named.
The election of new directors has seen and upward movement in the price of the stock in the last two days. The company now has new independent directors to replace four old independent directors. This means is that shareholder activists' needs are being met. The company's performance still pivots on the actions of management, who we all know nobody has any faith in anymore. Quite frankly, the company's CEO acted like an amateur. In an environment that has energy companies looking for any avenue to assuage investor fears and reward loyalty with dividend payouts, share buybacks and other methods meant to increase shareholder value, taking in excess of a $1 billion personal loan is the mark of an individual who has very little regard for the overall capital markets condition and rewarding shareholders for patience and loyalty. Chesapeake is a massive producer, paying out its management and principals like the gravy train will never end is a bad plan all around.
Chesapeake has hit the trifecta of bad investing, media attacks, lack of board transparency and complex financial structures which will necessitate asset sales to meet debt obligations. It could be worse, but not by much. Perhaps the new board members will breathe the necessary light and rationality into management which will cause them to act less like the company is an ATM, and more like a company responsible to its shareholders in order to increase value.
The makeup of the new board of Chesapeake has abided by shareholder demands to better execute its plan to deliver a higher stock price and better recognition of the company's underlying assets. The value of the underlying assets will continue to decrease as market prices for oil and natural gas remains low. It is up to the board and management to execute on all initiatives to properly reflect the value of the company's assets vis a vis the company's share price.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
