Chesapeake Energy: Patience Is Key

| About: Chesapeake Energy (CHK)
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Summary

Stock price has come under pressure again as oil prices fell.

OPEC members have a consensus for extension of supply cut agreement, which should take care of the elevated inventory levels.

Natural gas prices also have a bullish outlook as it emerges as a key fuel for power generation.

Chesapeake's fundamentals are not under threat and the stock price fall is temporary.

The company is profitable at $50 per barrel and will benefit considerably if the oil prices hit $60 by the end of the year.

Please follow this link to read my previous articles about Chesapeake Energy.

Chesapeake Energy (NYSE:CHK) has again come under pressure due to the concerns about oil inventories. And I will repeat that shareholders should be patient and wait for the market to take a definitive direction. Chesapeake has been extremely sensitive to developments in the oil market due to its increased debt exposure. Oil market is going through a unique change which requires patience from the market players. There will be volatility and each piece of news will result in jumps/drops in price for oil as traders try to come to terms with the new-found volatility in the market.

Keep in mind that the company does not face any imminent threat regarding its debt or assets. In fact, some of its assets will now become economical due to the rising commodity prices, which will result in stronger balance sheet. It will also offer the company an option to sell more non-core assets in order to raise funds for the capital budget or debt reduction. As Chesapeake has been moving towards liquids, we might see some sales in the natural gas segment of the company. Natural gas accounted for more than 75% of the total production for the company in the last year. However, out of 18 rigs that Chesapeake plans to utilize during the current year, 12 will be used for oil. The company has become a low-cost producer and it is making more money at $50 per barrel than it used to when the oil was near $100 per barrel. With oil prices expected to reach over $60 by the end of the year, Chesapeake is on track to be cash flow neutral by the end of the next year.

This Financial Times article (Might need to subscribe) sums up some of the work I have previously done on Chesapeake Energy. I agree with the industry analysts and has been saying this for the past eight months that Chesapeake is making progress but it is not yet out of the woods completely. The management has done an exceptional job of managing its debt and the next challenge is to grow production in a rising commodity price environment. The extension of debt maturities give a lot of breathing space to the company and rising commodity prices should allow the management to grow cash flows. Lower cost base should help in saving cash. However, investors should keep an eye on the oil market as it will be a volatile space and will affect Chesapeake Energy's stock price.

As I expected, there is a consensus among the OPEC members that the supply cut agreement should be extended. The organization has not agreed but the Saudi and Kuwaiti ministers are of the view that most of the members want to extend the agreement in order to achieve the price target. The organization is meeting on May 25, and the meeting will also include the non-OPEC members. Unlike the November meeting, OPEC members will be accompanied by the non-OPEC members. A consensus to extend the agreement might have played a part in a joint meeting for OPEC and non-OPEC members. The level of supply cut might be reduced in this meeting. Increased consumption during the summer and already falling global inventories might prompt the member nations to recommend a smaller supply cut for the second half of the year.

The supply cut agreement is giving results as the inventory levels in the producing nations are falling. However, the consumer areas like the US and Asia still have some surplus. Most of the OPEC members have reduced exports to these areas. This has created an arbitrage opportunity for the US and North Sea oil.

Source: S&P Global Platts

US shale and North Sea barrels are making up for the decreased exports from the OPEC members. It will be interesting to see how far these barrels can go in making up for the OPEC supply reduction. Refiners in Asia are also looking at these arbitrage opportunities and they are willing to buy North Sea and US shale oil. As the demand goes up in the next 2-3 months, Asian inventories might come down. US refineries are also back to full capacity and the crude oil is being refined at a higher rate in anticipation of summer driving season. Global oil market is going to be volatile in at least the short-term as the fundamentals are changing. Citigroup analysts might be a little too optimistic with their oil price target of over $60 by the end of the year. I believe we will see oil prices reach $60 in the second half of the year, but crossing $65 might be a big ask. However, if these levels are achieved, then Chesapeake Energy's cash flow neutrality target will become a lot easier.

In addition to the positive expectations in the oil market, we are going to see a bullish natural gas market as well. US natural gas exports to Latin America, LNG exports to Asia and use for power generation has been some of the key drivers for my bullish stance on natural gas. US will have a full year of LNG exports which should result in drawing down some of the domestic inventories. EIA is predicting that natural gas will be the largest source of power generation in the country during this summer.

Source: EIA

Natural gas is going to account for almost 37% of the total power generation during the year. This is good news for the market as there is potential for a decrease in inventories.

Both components of Chesapeake Energy's product portfolio have a bullish outlook. The market is currently focusing on the volatile oil prices. As more clarity comes to the prices, Chesapeake Energy stock price will start to move higher. Shareholders need to be patient and wait for at least the end of 2018. The management has done all the hard work and now the market fundamentals also seem to be moving in favor of the company. This is not a time to panic.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.