Chesapeake Energy Nears Bankruptcy

Summary

• Chesapeake appears likely to file for bankruptcy soon.
• The $134 million July 1st second-lien interest payment may serve as a deadline for the filing, although Chesapeake could elect to take the 30-day grace period for more time.
• Chesapeake is looking at over $300 million in 2020 cash burn with its $1.45 billion capex budget, despite solid hedges.
• Common shares are unlikely to see a recovery, due to Chesapeake's high leverage and the multiple classes above the common shares in the capital structure.
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I had expected in early February that Chesapeake Energy (NASDAQ:CHK) would more likely restructure in 2021 than in 2020. Its hedges provided a fair amount of protection for 2020, but it had no hedges for 2021 (other than some sold calls that limited commodity pricing upside a bit). Therefore, the most likely outcome was for Chesapeake to make it through 2020 and then file for bankruptcy in 2021 if oil and gas prices hadn't improved enough.

The oil price crash has put Chesapeake on track to either burn a significant amount of cash in 2020 or cut capex and reduce production further though. While it technically could survive into 2021 if its borrowing base doesn't get cut drastically, it is now very likely to soon file for bankruptcy due to any realistic path for survival being quashed now.

Updated 2020 Outlook

If Chesapeake doesn't cut its 2020 capex budget from $1.45 billion, then it would end up with approximately 456,000 BOEPD (25% oil) in average production during 2020.

At current strip prices (near $29.50 WTI oil and $2.15 NYMEX natural gas), Chesapeake is forecast to deliver $2.628 billion in oil and gas revenue. Chesapeake had guided for slightly positive oil differentials before but is now probably looking at realizing slightly less than WTI on the year. Gulf Coast benchmark oil prices are now commanding a narrower than usual premium to WTI.

Chesapeake's hedges add another $1.131 billion in value for 2020, mostly from its oil hedges after the crash in oil prices. Including hedges, Chesapeake is forecast to end up with $3.759 billion in revenue.

	Barrels/Mcf	Per Barrel/Mcf	$ Million
Oil	42,500,000	$29.00	$1,233
NGLs	12,000,000	$9.30	$112
Gas	675,000,000	$1.90	$1,283
Net Marketing And Other			$0
Hedge Value			$1,131
Total			$3,759

Click to enlarge

Chesapeake is projected to end up with $335 million in cash burn for 2020 now. This includes the effect of Chesapeake suspending its preferred dividends. Chesapeake does save a bit on projected interest costs compared to a few months ago due to the impact of the decrease in LIBOR on its $3+ billion in variable rate debt.

	$ Million
Production Expenses	$443
Gathering, Processing and Transportation	$1,090
Production Taxes	$158
Cash G&A	$217
Cash Exploration Expense	$30
Cash Interest	$684
Preferred Dividends	$22
Capital Expenditures	$1,450
Total	$4,094

Click to enlarge

In addition to the cash burn, Chesapeake had $301 million in unsecured notes (as of the end of 2019) maturing in 2020, although it repurchased a minority of those at a modest discount in January 2020.

Timing Of Bankruptcy Filing

The potential for substantial cash burn in 2020 followed by massive cash burn in 2021 at current strip prices has resulted in Chesapeake looking at a bankruptcy filing over the next few months. Chesapeake probably realistically needed WTI oil at $60+ in 2021 to avoid restructuring in 2021. There was still some hope early in 2020 that oil prices could get to that point for 2021 when 2021 strip was in the mid-$50s. Now with 2021 strip in the low-$30s, the odds of WTI oil averaging $60+ in 2021 is minuscule, so it makes sense that Chesapeake may file for bankruptcy soon.

Chesapeake has a $134 million bond interest payment due on July 1 for its second-lien notes. In May and June, it appears to only have $17 million in bond interest payments due. Thus, it is likely to file for bankruptcy before July, or skip the July 1st interest payment and trigger the 30-day grace period if it needed a bit more time for negotiations. Chesapeake also has up to $208 million (less whatever it repurchased in January) in notes maturing on August 15.

As well, Chesapeake is projected to end up with leverage at 5.0x EBITDAX at the end of 2020. This would leave it in violation of the 4.50x leverage covenant on its credit facility. Its $3.0 billion credit facility borrowing base is also scheduled to be redetermined in Q2 2020 and is likely to see a sizable reduction. Chesapeake may draw substantially on its credit facility to provide it with liquidity to see it through a bankruptcy filing.

Common Equity Recovery

If Chesapeake files for bankruptcy soon, I don't expect the common equity to see a recovery beyond potentially warrants. With Whiting Petroleum's bankruptcy, shareholders are scheduled to get 3% of the new equity. Whiting had just its credit facility debt, unsecured notes, and common shares though.

Chesapeake has credit facility debt, term loan debt (also first-lien, but junior to the credit facility in the collateral proceeds waterfall), second-lien notes, unsecured notes, preferred shares, and common shares. Those additional layers make it less likely that the common shares will see any actual recovery.

Conclusion

Chesapeake was likely previously planning on operating at neutral to positive cash flow during 2020 with the benefit of its hedges, and then potentially filing for bankruptcy in 2021 if oil and gas prices hadn't improved enough. The effects of the coronavirus appear to have made a mid-2020 filing inevitable though given that Chesapeake is now having substantial 2020 cash burn and needs oil prices in 2021 to improve close to $30 above strip.

Chesapeake's common stock was a bet on oil prices hitting the $60s by 2021, but with oil prices going the opposite direction, it is unlikely that the common stock will see a recovery. Chesapeake has many layers to its capital structure, reducing the odds that those lower down in the capital structure will receive anything.

Analyst’s 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.

Comments

[Brutal Energy Investing]

The discussion here seems way too negative.

Apply some of the metrics people discussed here, you will hardly find any E&P companies that worth their debt.

I am not sure common will worth anything. But one just can't use certain strips to value an E&P company. The certain strip is due to a very rare demand shock to both oil and gas.

I think commons and unsecured would NEED to push this into full blow Chapter 11 if they don't get a nice bone, drag the process on for couple years and hope the strips and peer multiples will recover. They have nothing to lose to wait for price/sector recovery.

The range of valuation is huge - EBITDA can range from 1.5 to 2.5 billions (depend on what pricing forecast one use), multiple can go from 3x to 6x depends on which peer group one use.

There is a reason the whole capital structure is not pricing rationally. (market value of common > market value of unsecured bond, some unsecured trades above 2nd, etc...)

Good luck everyone!

[bondsmoker]

"Apply some of the metrics people discussed here, you will hardly find any E&P companies that worth their debt."

You notice how many oil companies have gone bankrupt in the past 4 years?

Of those, how many resulted in recoveries sub 10% of par on the bond debts?

As for any tactics by common/unsecured - so long as 1 class above them is deemed impaired, then they lose all control.

Either the 2L debt, or term debt above the 2L, could be deemed impaired. By the likes of the 2L debt trading prices, it does seem like something senior will be deemed impaired.

[Brutal Energy Investing]

>> As for any tactics by common/unsecured - so long as 1 class above them is deemed impaired, then they lose all control.

Yes, but the process to "determine" the EV in the court will be time consuming and costly, and if the strips improve during that time frame, unsecured and commons will have a chance to get something.

For them, there is nothing to lose to push the things to the court if they don't get what they want in the court.

Many uses WLL's case as a proof that bond can get 10% of par... sure, it's possible here.

But at least compare CHK's assets with WLL's first.

[Flipper2058]

CHK stock maybe actually getting interesting assuming they can do a pre-pack and get recovery. The market cap is close to under 1% with firms like WLL getting 2.7%.
CHK is massively short too with borrowing fees ranging 230%.
Is chk to big and complex to do a pre-pack??

[Likrat ha-Tiferet]

@Flipper2058

flip, what do you think of the argument that this last round of drastic BV write downs makes *any recovery on junior debt/unsecured debt difficult; and therefore that the shareholders should get nothing? makes any sense to you?

[MarionPolk2017]

It is possible that an extended contested bankruptcy proceeding could be more favorable to equity investors, as energy prices might substantially increase in the next two years.

[Raw Energy]

@Flipper2058 -

Not impossible, depending on where the fulcrum security lies. The 2Ls would have a claim for $2.2 B and currently trade at $5.00. If the impairment rests with them, they would determine the fate of any pre-pack plan. One risk, even to them, is that the fulcrum is higher up in the cap structure ... but equity is given the 2-3% equity share as a "gift" rather than based on valuation. That would satisfy BK rules that say that a class can only recover something if classes ahead of them do, and leave the unsecured largely or completely out of recoveries.

A freefall filing would be costly and time-consuming, but if mgt. does not get what they want for equity now and thinks that 12+ months will improve things, that is also a real option. Warrants might bridge some of the valuation differences to move the thinking back to more of a pre-pack likelihood, though. Game theory, with very experienced players on all sides .....

[ekierklo]

The semi-annual coupon is due on the 2020 bond this Friday. IF they make this coupon payment that alone would that not pay for the bonds. Even if they declare bankruptcy these would still have senior claims albeit over a long period. Of course if they default on the payment that's game over. Don't know if the make-whole and sinking fund features make any difference.

[matthewxjr]

How much is left outstanding of that issue?

[ekierklo]

The final coupon and end-date is Nov 15 2020

[matthewxjr]

76 million outstanding as of 3/31/2020

[zeth241]

The fiduciary duty to shareholders should require they fire all the non-essential employees. Stop capex entirely and use the hedges & Operating revenue to pay down debt. Keeping the ship afloat! There should be real pain in the judicial system to those managers that do not follow that creed. Instead those asswipe BK attorneys and liberal judges expanded the view to include stakeholders which meant keep some jobs and management makes a fortune. One change would fix this. If you file for BK the entire Management staff loses their job with the restructuring. That would create the adversarial position that makes sure management is in lock step with shareholders. This is a battle worth having in Congress!

[Critical Scenarios]

CHK out with an 8-K regarding employee compensation. It seems to cut salaries and exchanges equity for cash incentives.

app.quotemedia.com/...

[bondsmoker]

Yep, $25 Million in cash payments - pre-paid - in lieu of equity bonuses.

Standard practice right before a bankruptcy filing - essentially retention bonuses, paid in advance.

$25 Million. Not bad bonuses for running a bankrupt company.

[marathonroad]

Yep. Ridiculous to be rewarded for bankrupting a company, though in this case I don't blame the current leadership for the idiocy that preceded them.

[Brutal Energy Investing]

You still think GPOR restructuring is hard to avoid? Since your article on GPOR restructuring, stock up a few times and so did the bond.

[Elephant Analytics]

Yes, I still think GPOR will have challenges avoiding restructuring in the end. They probably have 2 to 3 years though, and may be able to do some exchange for second-lien notes that buy more time too.

[Hmmmmmmmm]

Do you mind commenting on any non-core asset disposal, and its impact on your bankruptcy timeline?

Even if you think non-core asset disposal has zero probability, it would still be good to comment on this in your thesis, given the company has flagged non-core asset disposal in its 4Q19 results. Also Shell recently managed to sell its Marcellus assets, and EQT is close to sell non-core assets as well

I agree CHK equity is toast, but if you are commenting on bankruptcy timing, it may not be good to be silent on the topic non-core asset sale

[Smallfish]

Fed and the government inflated a lot of bubbles with QE and low interest rates, bubble is
everywhere, house, stock index, oil company and many other companies. If no such low interest rate, they won't be able to borrow so much money and have so serious over supply issue.

When the oil price collapses, the bust up time is here.

same thing for house, companies debt, many many other things.

[This2ShallPass]

One topic that's not being discussed - CHK has a prolific NG asset in Marcellus. It's a cash flow machine with break even at $1.5-$1.75. At these NG prices, they're going to do really well. Also, they typically don't hedge Q4 NG, this should juice up the Marcellus returns this year even more.

Is there a comparable recent Marcellus sale, just curious to see what it would be worth? I think they'll file for BK than sell Marcellus. But that one sale potentially could solve a lot of problems.

[Smallfish]

when gas is at 3 dollar, oil at 60, CHK was losing money.
Do you expect they will make money at current price?

[Elephant Analytics]

Marcellus should be worth $2+ billion. CHK is heavily hedged on Q4 2020 natural gas though.

[This2ShallPass]

That's surprising considering they're only 54% hedged overall, any idea what % of Q4 NG is hedged?

[bondsmoker]

Question is, what recovery on 2L & unsecured?

[Earl Grey]

I cannot buy the 11.5% bonds Reg 144, QIB. You think the recovery on the other bonds I bought at 7c will be more or less than 7% in a bankruptcy?

[Flipper2058]

Reuters reported a rights offering is expected, whether non-QIB's can be involved is unknown but unlikely.

[This2ShallPass]

There's no realistic assessment of CHK that'll show 2L being fully impaired, especially in bankruptcy. Anybody implying so is driven by fear and no understanding of the fundamentals of this company...

[Cuip99]

Nears bankruptcy! It has been running on fumes for several years. I feel sorry for all those people that have to deal with them in the Haynesville gas fields.

[gutcheck]

is tock still around 20 because of cchance of no bk ? if bk does stock go to 0 or any value in equity ?

[mjbratus1]

Should be interesting how CHK’s auditors, PwC, defends its audit opinion and not including a going concern disclaimer in the 10-k audit opinion...

What do they know that we don’t?

[mjbratus1]

Still now earnings release date....

[Denis_Z]

Question to Author, why NG $1.9 used for calculation?

NG June delivery $2, Oct is $2.5, Dec $3, Jan $3.1, Feb $3.1

And, we have NOT seen the production collapse yet, which will obviously follow with in few months (my guess 3-4 maximum)
CHK will likely see at least NG at $2.7 HH, that an Extra ~$500 M, means $150M of positive Cash Flow, assuming, oil stays where it is now (again Highly, Highly unlikely, unless all states stay on lock-down for the rest of the year)

Can you consider this in you calculations?

[Elephant Analytics]

CHK has a negative $0.25 natural gas differential - so $2.15 NYMEX gas equals $1.90 realized price.

Actuals for Jan to April is around $1.85, so if it averages $2.30 from May to Dec, average NYMEX price would be around $2.15.

Might be a little low given how gas has moved recently (strip is more like $2.20 NYMEX now), but you can't get to $2.70 realized natural gas in 2020 easily. That would require $3.50 NYMEX for May to Dec.

[Flipper2058]

Going concern is a 12 month outlook which it wasn’t a month or so ago.
I am not sure you need the auditors to confirm what’s already baked in the debt.

[Likrat ha-Tiferet]

@Flipper2058
@Elephant Analytics
isn't there some global "going concern" shenanigan at as part of the CV19? or did that never go into effect?

[fm5]

Every time someone Writes a Article like this the stock goes up

[vxmike]

Why not just cut the capex to the absolute bare minimum to run the company safely? Sounds like they have a lot more room to cut and thus wouldn’t burn cash. Is shale just allergic to production decreases even if BK is the result?

[marathonroad]

@vxmike Their inherent decline rate would become apparent in a matter of months if they go into blowdown mode and, at current NG & oil strips, I would guess their inherent decline poses cashflow problems pretty quickly.

[vxmike]

Sure, but drilling wells at below break-even pricing only exacerbates that...

[marathonroad]

@vxmike Not if you're able to issue/convert later maturing debt to finance the drilling in order to inflate your present cashflow and pay off the current debt. The problem CHK is facing now is that they aren't able to kick the can down the road any further via new debt.

[MarionPolk2017]

What if this forecast proves accurate?
Goldman Sachs raised its estimate for WTI Crude prices in 2021 to $51.38 per barrel from $48.50, expecting a gradual recovery in global oil demand and production cuts from OPEC+ and shut-ins elsewhere to support oil prices next year.

[Flipper2058]

You have to survive to be able to take advantage of future prices. You are right, newco CHK shareholders should Brno. Old CHK shareholders won’t (diluted maybe 99%) and no one believes all the detailed reports on them filing? Wow. That’s real denial kicking in.

[Q2000]

Thanks @elephant for your différent articles fact-based (I remember your covering of the SHLD saga ;) )

Based on this, what is your though of :

1. the risk-reward of CHK’s 2L note given that in the capital structure:
Ok, it is junior to 3b$ (credit facility + term loan) but it is senior to c.4b$ of unsecured notes... and currently trading @3.5cts on the dollar? (+5cts of accrued interest or maybe +0 if the price is already « dirty » )
=> I give you mine : it is look great

2. The possibility of a prepack chp11 with: equitization of all 2L and the unsecured notes(=> c.6b$ of debt out) and the 3b$ senior debt remaining?

3. The viability as a going concern of a CHK with only 3b$ debt (term loan + crédit facility) with current assets minus the chp 11 legal costs?

Thanks again for this good work!

[Flipper2058]

Unless you are $100m (QIB) that can buy 144A paper it’s likely the 2nd lien maybe a bad buy. Sadly this has become SOP and QIBs purposely making rights offering club members only and others get even more diluted.
I’d wait to see a RSA first.

[This2ShallPass]

"Unless you are $100m (QIB) that can buy 144A paper it’s likely the 2nd lien maybe a bad buy. "

Why do you say this? The 2L is trading now, why would it only be a better buy for QIBs..

[Likrat ha-Tiferet]

"QIBs purposely making rights offering club members only" is why

[This2ShallPass]

This is flawed on CapEx. First, assumes mid-point of guidance - in this environment it's safe to assume they'll try to hit the lower end of $1.3B.

And saying they won't cut CapEx to preserve oil production does not make sense. They have 25% Oil unhedged (10M barrels) and you can guarantee they won't drill any of this. No point losing $10-20 on every barrel.

Their CapEx guidance is 80% oil / 20% NG. If they cut 25% of Oil CapEx, you're looking at $1B for 2020 and that's more realistic. I don't think they lose $330+M in this scenario.

[Elephant Analytics]

I do agree that CHK is likely to cut capex, and that there are ways for it to minimize cash burn.

However, you also have a situation for 2020 where interest costs are roughly the same as unhedged EBITDAX. The debt is clearly unsustainable and it will probably run out of credit facility borrowing capacity sometime in 2021 if it avoids bankruptcy now anyway.

Since CHK is paying close to $700 million in annual interest costs and could get rid of $500 million of that in bankruptcy, it makes sense for it to file for bankruptcy now, rather than spend that $500 million plus the maturing bond payments just to file for bankruptcy next year.

[This2ShallPass]

I don't disagree the debt is an albatross and it might be prudent to use this env to shed a lot of it. I also have come around to believing BK this year will likely happen.

But, if you use $1B capex and 10M barrels not drilled, I feel the financials will look a lot different for 2020. Just curious, in this scenario what does your model predict 2020 cash burn to be?

[vxmike]

You don’t have to produce hedged volumes. Just cash out the financial contracts and turn off the drill bits.