Don’t Be Fooled By Chesapeake’s Low Price
There has been a lot of negativity regarding Chesapeake Energy (CHK) in the past year. For the most part, it’s been the result of poor decision making by CEO Aubrey McClendon. Many people have written negatively about McClendon so I will spare you more criticisms, but one thing is clear. Under McClendon, Chesapeake Energy has faced more controversy than any company would like to. If it is lucky, its new developments will overshadow McClendon’s unnecessary controversy.
Good news first, BMO recently raised its rating on Chesapeake Energy from market perform to outperform. Many analysts believe that Chesapeake Energy’s stock price, currently around $18, is too low. Also, many shareholders believe that some of the mess, caused by questionable loans by McClendon, is behind the company. I see little evidence to think this is the case however, as Newman Ferrara LLP and many others have just signaled they will be investigating Chesapeake Energy regarding these loans.
On the operations side, Chesapeake Energy faces many threats to its profitability. As a company with a high stake in natural gas exploration, it has seen diminishing returns as the price of natural gas has plummeted. To make matters worse, natural gas exploration is a risky endeavor, a fact that has reared its ugly head too often lately.
Up until this point, Chesapeake Energy escaped the plummeting natural gas prices by hedging these prices in the futures market. This buoyed any losses due to the drop in natural gas prices as many traders took these futures contracts and lost. These profits are not sustainable, as natural gas prices have dropped so far that Chesapeake can no longer profitably hedge on prices. It will need to find new revenue sources or somehow make natural gas lucrative again. Don’t expect it to accomplish the latter.
Adding to the low prices, Chesapeake Energy has had troubles with its natural gas wells as of late. First, in Wyoming, one of its gas wells sprung a leak forcing many to evacuate their homes. While this is not a catastrophe, it certainly hurts an already reeling image. A corporation that cannot maintain profitably in its natural gas division having problems drilling natural gas looks very poor at best.
Add to the scrutiny that fracking has come under in the past year and there is a recipe for failure in the natural gas industry. A researcher just published a study that links the sand dust caused by fracking to severe health problems in workers. He says that it is one of the most dangerous threats to these workers. You can expect natural gas exploration companies will try to find solutions to these problems. Of course, this aspect adds more cost to natural gas exploration, decreasing its sinking profitability even further.
Needless to say, Chesapeake Energy is not taking this news lying down. In fact, it is frantically trying to come up with profitable solutions to its natural gas problem.
One route it’s taking is a partnership with General Electric (GE). The two companies have partnered in an attempt to speed the adoption of natural gas as a transportation fuel. The companies want to accomplish this by developing infrastructure that will decrease the time it takes to incorporate natural gas into transportation. For Chesapeake Energy, this is a way to increase demand for natural gas. Doing so could elevate the rock bottom prices on natural gas to more profitable levels. This is not a bad solution, as many have expressed interest in using natural gas in transportation, as some believe it is less harmful to the environment than oil.
Don’t think Chesapeake Energy has gone green, though. Its other solution to the natural gas problem is to produce more oil. Since oil has higher margins than natural gas, a successful oil well will bring in more money for Chesapeake Energy. With a production mix of 80% natural gas and 20% oil, Chesapeake Energy has a long way to go. To get its oil production ratio higher, it needs large investments of cash, and cash it does not have.
Compared to its largest competitor Exxon Mobil (XOM), Chesapeake Energy appears to be in even worse shape. Exxon Mobil’s stock was hit by the low natural gas prices much as Chesapeake Energy’s stock has been hit. The difference is that Exxon Mobil has diversified oil ventures throughout the world. One example is the contract it signed with Rosneft last week. This deal could start over $500 billion of investments in offshore drilling in Russia. Notably, this is an oil exploration venture, and being the first into the market, such as Exxon Mobil is, will yield huge profits.
Another major energy company, Chevron (CVX) is blowing Chesapeake Energy out of the water. Again, this is due to its high concentration in the oil exploration market. If some experts are to be believed, oil is the future of the United States economy. This might be true, as even with a fall in the production of oil, Chevron’s profit still increased 4%. These are the high margins Chesapeake Energy hopes for.
It is hard to have a positive outlook on Chesapeake Energy. It is currently experiencing a perfect storm of bad news. When the best news about a stock is that it is lowest all-time levels, the stock might be in trouble. It predominantly produces natural gas but wants to produce oil. To produce oil it needs money, but since it predominantly produces natural gas, it does not have the cash to invest in oil ventures. Yes, I would say it is in trouble and there’s seemingly no good solution in sight. 