One month into the third quarter, Chesapeake Energy Corporation (CHK) is hoping to close on some of its previously announced asset sales in order to raise much needed cash. Earlier this year, CEO Aubrey McClendon indicated that he hoped the sales would move quickly, but as the year draws on and none of Chesapeake's major asset dispositions move publicly towards final sale, this hope is proving ill-founded.
Legal Troubles Cloud the Horizon
Chesapeake is currently the target of numerous lawsuits, many of which center around claims of breach of fiduciary duty. Although it indicated earlier this spring that the board is thoroughly investigating McClendon's financial arrangements and re-iterated that the investigation is ongoing in its second quarter earnings report, Chesapeake's failure to put the investigation on the fast track is hurting the company. Though it is certainly a complex matter, I don't think that it should be taking the company this long to release an update.
The longer Chesapeake waits to release the results of its investigation, the more disillusioned stockholders become with the stock amidst its other problems. There are also new lawsuits emerging, the latest of which was filed last week in Houston. The suit, brought by MDU Barnett LP, alleges that allowing McClendon to purchase leases on Chesapeake's wells was preferential treatment, due to contracts that required the company to offer the same stakes and potential profits to existing leaseholders, which it did not. The suit also alleges that Chesapeake underpaid leaseholders under a system rife with accounting errors favorable to Chesapeake.
Chinese Investment Unlikely to Be Enough
Chesapeake's sometime-partner Sinopec made news earlier this month when it announced a plan to invest up to $1 billion in clean coal in West Texas. For Chesapeake, this must be tantalizingly close to its Permian Basin assets currently held for sale, but at least publicly Sinopec is not making indications that it is interested in the oil heavy holdings. Some analysts are suggesting that the clean coal project is an initial move for Sinopec to purchase Chesapeake's Permian Basin assets, but I don't think that this is the case. Sinopec is not showing much interest in becoming an unconventional operator in its own right, and though it has multiple investments in U.S. shale, it is as a partner.
Even in its largest deal, a $2.5 billion joint venture with Chesapeake competitor Devon Energy Corporation (DVN), Sinopec only owns a 33% stake in the fields covered in the deal. For Sinopec to go from a joint venture partner to an outright operator with fields the size of Chesapeake's Permian offerings overnight would be unexpected, to say the least, especially given that the fields are oil heavy and what Sinopec is really after appears to be knowledge on extracting unconventional natural gas to fuel China's booming demand for the fuel.
Sinopec is not the only firm from the Asia-Pacific region looking to obtain knowledge on U.S. shale gas extraction techniques. Hess Corporation (HES) recently established a joint venture with PetroChina to assess and develop one of China's many possible shale oil reserves, the Satanghu Malang Trough, which has probable reserves around 2.6 bboe.
The Hess project is unconventional for Chinese companies, since government restrictions on refining prevent Chinese producers from realizing a profit. PetroChina and others are looking to expand their international holdings, but that does not mean that they will do so in the U.S. United States natural gas export is limited and land prices are already inflated, so I think it is more likely that the international exploration boom about to take place will be in underdeveloped areas within the Asia-Pacific and possibly Russia, which will also reduce transportation costs.
An example is Cnooc Ltd.'s recently offer of $15.1 billion for Nexen, Inc. (NXY) in an all cash deal. If approved, this would be the biggest overseas energy acquisition by a Chinese company to date. In North America, Canada based Nexen participates in off shore oil drilling in the Gulf of Mexico, natural gas exploration in British Columbia, and oil shale mining in Alberta. It also has offshore oil drilling interests in the North Sea and Nigeria. These various interests and drilling techniques would provide a clear benefit to Cnooc, with the advantage that it could export oil and natural gas using facilities already in place on the Canadian coast.
Sinopec would not be able to leverage as much out of a potential Permian deal with Chesapeake. Although I would not put a Sinopec/Chesapeake joint venture out of the realm of possibility, a joint venture would not give Chesapeake a foothold on the billions of dollars it needs to raise by the end of this year to stay solvent, making a deal less likely for either party.
Chesapeake is being accused of submitting a bi-annual Marcellus Shale production report to Pennsylvania authorities so rife with errors that the state database rejected it. According to an energy department spokesman, the errors included attempts to report more producing days than were in the reporting period and reporting drilled wells as not yet drilled. The Pennsylvania Department of Environmental Protection released its report for all producers without revealing that Chesapeake's numbers were removed, which due to Chesapeake's leading position on the play led to a wildly inaccurate report overall until corrections were submitted.
The corrections, however, are revealing; although Chesapeake is still a top Marcellus producer, it owns none of the top producing 25 wells in Pennsylvania. All 25 of the top wells are owned by competitors Cabot Oil & Gas Corporation (COG), which has eight of the top ten wells, or private Citrus Energy. This shows that Chesapeake is losing its foothold on the play where it used to be king. Although part of this is intentional, as Chesapeake scales back its participation in natural gas by reducing rig counts on the play, losing its leading position is a setback that will be difficult to overcome.
Chesapeake is currently trading around $19, with a price to book of 0.9 and a forward price to earnings of 10.2. Devon is trading around $58 with a price to book of 1.0 and a forward price to earnings of 8.5. Hess is trading around $50 with a price to book of 0.9 and a forward price to earnings of 7.2. Nexen is trading down, around $25 with a price to book of 1.5 and a forward price to earnings of 10. Finally, Cabot is trading around $41, with a price to book of 4.0 and a forward price to earnings of 43.5.
I believe that despite public statements to the contrary, the leadership team at Chesapeake is growing nervous about the company's future. Investors are certainly wary of the stock, recently pushing it downwards after a brief uptick earlier in August, and I think that unless Chesapeake makes major moves to a real turnaround by the end of this year, the stock could settle back around the $13 lows it saw earlier this year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.