Feb 22 2012

Shale Gas Bubble?

Chesapeake Energy’s Cash Troubles;

Plus Nine “Most Likely” Takeover Targets in Shale Gas

Are We Watching the Tipping Point?

Perhaps Real Shale Gas “Insurgents” ARE the Industry?

Watching current events in the shale gas industry recalls the warning from Andy Grove, co-founder of Intel:  Success contains the seeds of its own destruction.

  • Following persistent rumors in Oklahoma and Texas, Chesapeake Energy announced it will raise $10-$12 billion through asset sales in order “to get through the next year or so without going bankrupt,” according to Forbes magazine.1  Chesapeake Energy is said to be the nation’s second-largest nat gas producer after ExxonMobil.
  • Range Resources – once dubbed “king of the Marcellus” by Forbes – is on the ‘short’ list of nine Exploration & Production companies viewed as “most likely” takeover targets in a research report by UBS.2

Chesapeake Energy in Trouble?

At least two weeks before Chesapeake Energy announced updates to its 2012 operating plan, industry rumbles from Oklahoma to Texas suggested the company is in trouble.

The rumors came via folks connected to the energy industry; and they speculated that time and money are running out and, yes, maybe even bankruptcy is a possibility for Chesapeake.  These rumors noted that Chesapeake was already cutting contracts for drilling, and claimed that employees in Oklahoma City are worried about jobs.

Such rumors are just that and the reference to possibly “going bankrupt” in Christopher Helman’s Forbes piece (Feb. 13) was soon deleted from the lead paragraph – an exercise in measured reporting given the complexity of the company.

Junk Bonds

Yet, the company’s bond credit ratings are BB+, which is “non-investment grade speculative” – in other words, junk bonds.3

To add to its current challenge, Chesapeake is on the longer list of 13 “likely” takeover targets in the same UBS research report on Energy Sector Mergers & Acquisitions.2 

Chesapeake did not make the UBS short list of nine “most likely takeout targets” that includes Range Resources, Southwestern Energy, Anadarko Petroleum and Cabot Oil & Gas.  Instead, Chesapeake Energy moved into the “less likely takeout targets,” based on a number of factors detailed in the report (see footnote 2 under Links & Resources below for a copy of the report).

UBS researchers did note (emphasis added), “While CHK significantly outspends organic cash flow, the company is able to meet its cash flow short fall with proceeds from sale of non-E&P [Exploration & Production] assets, joint ventures, VPP [Volumetric Production Payment] and royalty trusts.”

This point is echoed in the Forbes piece which notes (emphasis added) that the company “is in a bind. … Chesapeake isn’t generating enough cash.”  And “… there’s no telling whether even Aubrey McClendon’s legendary financial finagling will be able to save the day.”

Forbes said Chesapeake’s updated financial plan “starts with the creation of a ‘volumetric production payment’ [VPP] structure tied to its Texas Panhandle Granite Wash Fields.”

Volumetric Production Payment – VPP

It characterizes VPPs as follows (emphasis added):

“These VPPs are a convoluted, but not unusual, structure whereby Chesapeake receives cash upfront (about $1 billion in this case) in exchange for delivering future volumes of oil and gas from the designated fields. … But for all intents and purposes it’s like issuing debt that needs to be repaid in oil and gas instead of cash.”

Deborah Rogers on Failed Production Models

I asked Deborah Rogers, founder of the Energy Policy Forum, for her assessment of the Chesapeake announcement.  She lives in the Fort Worth area and is described by another Texan as “wicked smart.”

Her financial career began in London where she worked in venture capital financing.  Returning to the United States, she worked as a broker with Merrill Lynch and Smith Barney.  In addition, she has served on the six-member Advisory Committee for the Federal Reserve Bank of Dallas.4

In public forums, she challenges the energy industry as a “failed production model.”  In her view, “I believe shale gas is more about exploiting capital markets than exploiting natural resources,” she says.

“It is about drilling for dollars in the financial markets.  Natural gas is simply a façade which enables this to occur more efficiently,” she says. “Hence the unmitigated disregard for disciplined drilling which would keep prices at viable levels.”

Assessing Chesapeake’s latest announcement, Rogers says (emphasis added):

“Firstly, VPP’s (volumetric production payments) are a form of off-balance-sheet financing that McClendon is trying to spin to sound like a clever accounting tactic. He has been using them for quite some time.”

“In my opinion, I think Chesapeake was essentially forced to resort to VPPs because other funding sources were drying up for them.”

“Nevertheless, debt is debt.  Whether you pay in cash or in production, you still have to pay at the end of the day and that is a form of debt no matter how much spin you care to apply. Chesapeake already has a great deal of debt so this will merely add more.”

“Likely Takeout Targets”

Elsewhere in the energy sector, there is a lot of takeover talk.  Matt Pitzarella, PR guy for Range Resources, tells Bloomberg/Businessweek, that the company doesn’t comment on such speculation.5

Pitzarella gained notoriety at an industry PR conference in Houston where he recommended the use of military psy-ops specialists as part of the shale gas industry’s effort to rebuild public trust.  At the same conference, a colleague of his – Matt Carmichael of Anadarko Petroleum – said (emphasis added), “we are dealing with an insurgency,” referring to citizen and property owner opposition in drilling communities.6

These remarks are on the public record (see footnote 6).  Given the industry’s behavior, why is it puzzled about the fact that it is losing public trust?  (The industry acknowledges it is losing in the court of public opinion.)

Meanwhile the financial underpinnings of the industry continue to shift – or slide, as the case may be.  Here are two excerpts from the UBS research report:

  • Range Resources – “We believe it is a matter of when not if Range Resources is acquired.”
  • Anadarko Petroleum – “… we believe Anadarko is a willing seller and note CEO Jim Hackett has been a seller in the past (Seagull Energy, Ocean Energy) and would be one of the biggest compensation beneficiaries amongst E&P [Exploration & Production] CEOs from a change in control.”

Perhaps some shale gas companies will wake up to discover a new kind of “insurgent” from their own industry – instead of among citizens and property owners.

 Links & Resources

1 “Chesapeake Energy’s New Plan:  Desperate Measures For Desperate Times,” Forbes, February 13, 2012 by Christopher Helman – http://www.forbes.com/sites/christopherhelman/2012/02/13/chesapeake-energys-new-plan-desperate-measures-for-desperate-times/

The online lead paragraph was edited to delete the reference to possible bankruptcy.  Originally, it read:  “This morning Chesapeake Energy announced a new financial plan that it hopes will allow it to raise the billions in cash it needs to get through the next year or so without going bankrupt.”

The Forbes article also contains hot links to Chesapeake’s “new financial plan.”

2 UBS Investment Research: Energy Sector M&A – pdf file:  EnergySectorMA    See especially pp. 1, 4-8.

3 Wiki Bond Credit Ratinghttp://en.wikipedia.org/wiki/Bond_credit_rating

Investopedia on Corporate Credit Ratinghttp://www.investopedia.com/articles/03/102203.asp#axzz1mrj0fbhK

4 Energy Policy Forum, founded by Deborah Rogers http://energypolicyforum.com/

5 “Range Resources at 56 Times Profit Cheap in Shale Boom:  Real M&A,” February 14, 2012, Bloomberg by Tara Lachapele and Mike Lee – http://www.bloomberg.com/news/2012-02-15/range-resources-at-56-times-profit-cheap-in-shale-boom-real-m-a.html

6 “Oil Executive:  Military-Style ‘Psy Ops’ Experience Applied,” November 8, 2011, CNBC by Emon Javers – http://www.cnbc.com/id/45208498

The CNBC coverage includes audio links for the comments made by Pitzarella and Carmichael.

NOTE:  This article is cross-posted on the Accountability Central website at this link: http://www.accountability-central.com/nc/single-view-default/article/voices-from-the-shale-shale-gas-bubble-chesapeake-energys-cash-troubles-plus-9-most-likel/  Accountability Central is part of the Governance & Accountability Institute, Inc.

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